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The maths behind aiming for mortgage-free
ScoobyLoot
Posts: 46 Forumite
Aiming to be mortgage free has its benefits, but they're not always that big if you consider the final balance in your pocket at the end of the original mortgage term. And really, that's what you need to calculate rather than how much interest you're avoiding paying.
On getting my mortgage I found out how the bank calculates it, and reproduced my mortgage in a spreadsheet that is accurate to the penny. This is great because it lets me calculate payments and try out scenarios on the mortgage to see what effect they have on completion date, total interest paid, the lot. Of course it requires some assumptions about the future, but it's at least illustrative to compare one against another since any changes in rates would affect all scenarios.
I've been doing some serious number-crunching, and my findings may be surprising to all you MFWs. Firstly a few key points:
- When you payments are recalculated, they are always calculated according to the ORIGINAL term of the mortgage. Thus, if you pay the amount asked, you will always complete your mortgage at the full term, say 25 years. Any time the mortgage is recalculated, it is usually done to the original term.
- Paying lump sums into the mortgage at refixing points does NOT reduce the span of the mortgage, but DOES reduce your payments,
- Overpaying every month DOES reduce the term of the mortgage, so if you want to shorten the life of the mortgage this is the only way to go. This only works if you keep doing it.
If, however, you are considering the total amount of money that will be in your pocket at the end of the original mortgage term, it will comprise the following:
* Your current savings, compounded at savings rates for the mortgage term.
* Any additional monthly savings by reduced payments compounded at savings rates for the actual life of the mortgage.
* The spare cash once mortgage-free, compounded at savings rates up to the original completion date of the mortgage.
You MAY think that piling savings into the mortgage when it's due for refixing (if you're on a fixed rate) will lead you to be better off later, when you think of the interest you'll save, but you could be wrong.
Piling a lump sum into the mortgage doesn't necessarily pay for itself in the long term as I'll show later. Why? Any savings you lose now can't be compounded for the lifetime of the mortgage so compared to the optimum strategy, it can actually cost you more than it saves.
Some examples: I currently pay over £1000 a month including over-payments on a 6.29% mortgage. Dropping to a modest interest rate of 4%, I can reduce my payments by £400 a month. How well off I end up at the end of the mortgage depends on what I do with that £400pcm.
If I don't overpay at all, my mortgage still finishes at its original completion date. In my case, current savings compounded, plus £400pcm compounded, plus the saving in interest from the lower rate, gives a final pot of £162,000 if I just pay the amounts asked.
This is where things get interesting. If I dump £10K into the mortgage now before changing rates, the pot becomes £166,000. i.e. I pay £10K in and get £4K back over 20 years time. Not a good return! Letting £10K compound at 2.5% will bag over £6K in interest, not a LOSS of £6K. The interest rate needs to be higher for this to work... but even then the returns are rubbish at best.
Dumping £10K in, and overpaying by at least 65% brings the pot to £164,000 after 20 years, where 9 of those years are mortgage free. £2K better off than just paying the default amounts, which over 9 years gives you next to nothing to play with once mortgage-free. ....and the money you aren't saving now by overpaying can't be clawed back after becoming mortgage-free even if you save all of it up to the original completion date (i.e. paying yourself as if you were still paying the mortgage). You lose out on compounding of interest.
If you're thinking you can go spending freely after paying your mortgage off early, you could EASILY be worse off than if you just left the mortgage paid as normal.
Back to the examples... dumping cash in and overpaying in the above case isn't as efficient as just overpaying to the same 65%. Just overpaying, the final pot becomes £180,000. So, that's £18,000 better off than just paying the default mortgage amounts, BUT still finishing 9 years early.... and what this basically means that if I spend more than £2K of my mortgage-free income a year, I'm no better off than if I just paid the amounts the bank asks for!
So, in summary, the best strategy seems to be to hold onto whatever savings you have now, rather than use them to reduce your mortgage payments. The loss you get for putting lump sums in now doesn't make up for it. And if you pay off your mortgage early, you need to act as if you still have one until the original term date expires, or it's easy to be no better off for all your hard work paying it early!
Being a MFW is rather missing the point if you look at it from the view point of how much money you can have in your pocket at the end of the mortgage term. You may think you're getting one over on the bank, but really, you're not. Yeah you're reducing the interest amount, but what's left in your pocket won't be a lot different.
Don't get too fixated on the interest reduction on your mortgage... as with most economics, using a single index doesn't yield a true picture.
And this is where offset accounts start to look interesting... but only if the amount you're offsetting if the majority of the capital balance on the mortgage, and the quicker you can accumulate such an amount, the better.
On getting my mortgage I found out how the bank calculates it, and reproduced my mortgage in a spreadsheet that is accurate to the penny. This is great because it lets me calculate payments and try out scenarios on the mortgage to see what effect they have on completion date, total interest paid, the lot. Of course it requires some assumptions about the future, but it's at least illustrative to compare one against another since any changes in rates would affect all scenarios.
I've been doing some serious number-crunching, and my findings may be surprising to all you MFWs. Firstly a few key points:
- When you payments are recalculated, they are always calculated according to the ORIGINAL term of the mortgage. Thus, if you pay the amount asked, you will always complete your mortgage at the full term, say 25 years. Any time the mortgage is recalculated, it is usually done to the original term.
- Paying lump sums into the mortgage at refixing points does NOT reduce the span of the mortgage, but DOES reduce your payments,
- Overpaying every month DOES reduce the term of the mortgage, so if you want to shorten the life of the mortgage this is the only way to go. This only works if you keep doing it.
If, however, you are considering the total amount of money that will be in your pocket at the end of the original mortgage term, it will comprise the following:
* Your current savings, compounded at savings rates for the mortgage term.
* Any additional monthly savings by reduced payments compounded at savings rates for the actual life of the mortgage.
* The spare cash once mortgage-free, compounded at savings rates up to the original completion date of the mortgage.
You MAY think that piling savings into the mortgage when it's due for refixing (if you're on a fixed rate) will lead you to be better off later, when you think of the interest you'll save, but you could be wrong.
Piling a lump sum into the mortgage doesn't necessarily pay for itself in the long term as I'll show later. Why? Any savings you lose now can't be compounded for the lifetime of the mortgage so compared to the optimum strategy, it can actually cost you more than it saves.
Some examples: I currently pay over £1000 a month including over-payments on a 6.29% mortgage. Dropping to a modest interest rate of 4%, I can reduce my payments by £400 a month. How well off I end up at the end of the mortgage depends on what I do with that £400pcm.
If I don't overpay at all, my mortgage still finishes at its original completion date. In my case, current savings compounded, plus £400pcm compounded, plus the saving in interest from the lower rate, gives a final pot of £162,000 if I just pay the amounts asked.
This is where things get interesting. If I dump £10K into the mortgage now before changing rates, the pot becomes £166,000. i.e. I pay £10K in and get £4K back over 20 years time. Not a good return! Letting £10K compound at 2.5% will bag over £6K in interest, not a LOSS of £6K. The interest rate needs to be higher for this to work... but even then the returns are rubbish at best.
Dumping £10K in, and overpaying by at least 65% brings the pot to £164,000 after 20 years, where 9 of those years are mortgage free. £2K better off than just paying the default amounts, which over 9 years gives you next to nothing to play with once mortgage-free. ....and the money you aren't saving now by overpaying can't be clawed back after becoming mortgage-free even if you save all of it up to the original completion date (i.e. paying yourself as if you were still paying the mortgage). You lose out on compounding of interest.
If you're thinking you can go spending freely after paying your mortgage off early, you could EASILY be worse off than if you just left the mortgage paid as normal.
Back to the examples... dumping cash in and overpaying in the above case isn't as efficient as just overpaying to the same 65%. Just overpaying, the final pot becomes £180,000. So, that's £18,000 better off than just paying the default mortgage amounts, BUT still finishing 9 years early.... and what this basically means that if I spend more than £2K of my mortgage-free income a year, I'm no better off than if I just paid the amounts the bank asks for!
So, in summary, the best strategy seems to be to hold onto whatever savings you have now, rather than use them to reduce your mortgage payments. The loss you get for putting lump sums in now doesn't make up for it. And if you pay off your mortgage early, you need to act as if you still have one until the original term date expires, or it's easy to be no better off for all your hard work paying it early!
Being a MFW is rather missing the point if you look at it from the view point of how much money you can have in your pocket at the end of the mortgage term. You may think you're getting one over on the bank, but really, you're not. Yeah you're reducing the interest amount, but what's left in your pocket won't be a lot different.
Don't get too fixated on the interest reduction on your mortgage... as with most economics, using a single index doesn't yield a true picture.
And this is where offset accounts start to look interesting... but only if the amount you're offsetting if the majority of the capital balance on the mortgage, and the quicker you can accumulate such an amount, the better.
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Comments
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Using the same amount of money over the same period if the savings rates are lower than the mortgage then you cannot be better off saving rather than overpaying the mortgage.
The one exception is the use of ISAs which have a TAX free element so can make it better to save than overpay since these TAX saving last longer than the mortgage.
The crux of your story seems to be that you spend money it you worse off, fairly obvious.0 -
A further point missed is that some of your money now available once MF early (in our case we'll be paid off 10yrs early, but we've been significantly offset the last couple of years and we always OP) can be invested for long-term growth in the markets because you have the security of a property etc. Thus you can significantly increase your returns especially if you have these in Funds or Equities within ISAs.where all the growth is also tax-free alongside your cash ISA also growing tax-free.
From April 2010 we will all have access to £10200 ISA allowance for tax-free returns; I'm not aware of many couples with a mortgage who can put in £20k pa plus take the risk on at least half in the markets....
Historically, mortgage rates have always been higher than savings rates, but in the last, say 5yrs this has changed. It's unclear it will remain the case in future. We started at a time of moderate mortgage rates 8% vs typical 13% in the preceeding years, who can predict the rates over the next 4yrs?0 -
Pay off mortgage = £850 free in my pocket each month.
Don't pay off mortgage = £0 free in my pocket each month.Mortgage start September 2015 £90000 MFiT #060 -
I agree, mathamatically it makes a lot of sense to save rather than overpay but life doesn't work like that.
A lot of people prefer, as the poster above, the extra income each month.
Some people see it as a longterm debt they can't wait to get rid of.
Some people just want to know that they completely own a house.0 -
Sorry OP but you have deliberately obfuscated the issue. It just boils down to the following:
If mtg IR > Savings IR then overpay.
If Savings IR > mtg IR then save.
Furthermore, you have completely forgotten about the money you could save once mortgage free. Finally, when you make a lump sum overpayment, you can either reduce the term OR reduce the monthly payments.
Back to the drawing board......In case you hadn't already worked it out - the entire global financial system is predicated on the assumption that you're an idiot:cool:0 -
We're (my OH and I) are MFWs because we want peace of mind that we can get rid of our mortgage quicker-giving us the flexibility to either be totally mortgage free earlier or so we can move to a bigger house without having to have a bigger mortgage than the one we currently have.GE 36 *MFD may 2043
MFIT-T5 #60 £136,850.30
Mortgage overpayments 2019 - £285.96
2020 Jan-£40-feb-£18.28.march-£25
Christmas savings card 2020 £20/£100
Emergency savings £100/£500
12/3/17 175lb - 06/11/2019 152lb0 -
It depends what your goal is. I would think most people want to have as much money as possible later in life and to maximize that pot. After all, they are paying off the mortgage early usually because they think of interest savings and want to maximize their money.
If you just want to know that the house is entirely yours, that's fine; if you just want all your salary to play with NOW that's also fine. Whatever makes you feel content, it's not for me to say what you personally should do.
Martin Lewis may shout a lot and point at people telling them what to do but even he looks at the wrong figure - the saving in interest - rather than the overall effect of any strategy on your end pot and that is where you need to look to see what difference, if any, a given approach is making.
I'm all for saving money and having more in my pocket - it is after all what everyone on this forum wants and why they're here. I did the maths because I wanted to cut through the simplistic arguments of one interest rate versus the other, and having X in my pocket each month versus not - the things you would automatically think were better - and get to what the actual end result is of taking different strategies with the mortgage.
If I pay off my mortgage early in 2020 rather than 2029 then yeah, I'd have an extra grand a month to play with for those 9 years, but I'd need to pay that grand into my own savings every month in order to have any benefit by the original term finish date in 2029. In which case, my disposable income will be no different to paying the mortgage. If I spent that extra grand a month, I'd be worse off - simples.
I'm going to run some more figures this weekend.0 -
The goal of this board is to be mortgage-free regardless of how the maths works.Mortgage start September 2015 £90000 MFiT #060
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No, I haven't.Furthermore, you have completely forgotten about the money you could save once mortgage free.
As stated, I am better off at the end of the original term BUT only if I save all those pounds as if I were paying the mortgage. The margin for spending some of that money is tight. And as my calculations showed, in real terms I'd be £18,000 better off by 2029 in terms of what is in my pocket, NOT the overly simplistic view of how much interest I'd saved on the mortgage.
Mathematically, what this is trying to do is to minimize the cumulative difference in the effects of savings interest and mortgage interest. Mess with one and you offset the benefits of the other, and vice versa. The interaction is a lot more complex than "this number's bigger than this one".
I was talking about my own mortgage, and as was plain, my calculations are based on the original term with the option to reduce payments. Saying "ah, you missed this" doesn't actually make everything else wrong. If I reduce the term, I increase my payments and you're back to messing with incomings and outgoings again and cumulative effects.Finally, when you make a lump sum overpayment, you can either reduce the term OR reduce the monthly payments.
If what matters to you is the amount of money you have as a result of money in versus money out over time, then you need to have a much deeper look than a cursory glance at two numbers.Back to the drawing board......0 -
The goal of this board is to be mortgage-free regardless of how the maths works.
heheheh that is indeed the goal Floxxie. I just wanted to know what the effects of different approaches were, and thought others might be interested to know what it meant from a different angle. Little did I know it'd be like being Darwin confronting the religious beliefs of others :rolleyes: :rotfl:0
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