Are my maths right?

tallpaulunderwood

Please bear with me as I work through the following, there's quite a few numbers in here & it’s a bit lengthy…..

THE BACKGROUND

Following the FSA rejection of the complaint of our mis-sold endowment, we're having to look at our mortgage quite closely. As of today, we now have

Total mortgage of 153,000, of this
57,800 will be interest only
95,200 will be on repayment
The term of the mortgage is 12 years

We are also fortunate in that we have a variety of investments, which added together, are worth about 77,000.

So, if nothing changes, I believe that in 12 years time we have the following....

Our 77,000 investment will have grown (assuming 5%) to 131,000
The endowment will have matured and will pay out (fingers crossed) 57,800

We will have paid a mortgage of £1080 per month, totalling 155,520 & will have to pay the final 57,800 to cover the interest only part.

So our 'net-worth' in 12 years time will be income (131,000+57,800) minus outgoings (155,520+57,800)....

Which is -£24,520, yes that’s a minus, :-(



THE CHOICES

It’s not all bad though. We see a couple of alternative choices. We could either

(1) Use our 77,000 investment to pay of a lump sum of the mortgage now & keep the remainder going for the current 12-year term. This would result in a lower monthly mortgage charge & we could save the difference. Or,

(2) Use or 77,000 investment to pay of a lump sum of the mortgage now &, switch the whole mortgage to repayment, keep the monthly payments the same & pay the mortgage of earlier. Once paid off, we could then continue to save the equivalent of our mortgage payments up to the 12 year deadline & then pocket the proceeds of the endowment maturing.


Hope you're keeping up !


Instinct tells me that, over the long term, we'd be better with option 2, but have a look at the following figures....

Option 1

By paying off a 77,000 lump sum, our mortgage changes to
57,800 interest only
18,200 will be on repayment
The term of the mortgage remains at 12 years.

This gives a, much more palatable, monthly payment of £385.
Lets say we then place the £695 monthly surplus (the original mortgage amount 1080, minus the new amount 385) into a savings account at 5%; over 12 years this grows to a healthy 132,000

So, 12 years hence,

The endowment will have matured (fingers crossed) and will pay out 57,800

We will have paid a mortgage of £385 per month, totalling 55,440 & will have to pay the final 57,800 to cover the interest only part.
We will have in the bank, savings of 132,000

So our 'net-worth' in 12 years time, in this instance, will be income (132,000+57,800) minus outgoings (55,400+57,800)....

Which is a positive £76,560 :-) which looks a lot better to my untrained financial eye !


Option 2, however, which I thought would be better, look at this…..

By paying off a 77,000 lump sum, our mortgage changes to
57,800 interest only
18,200 repayment

However, we switch the whole mortgage (76,000) to repayment & keep the monthly payments the same. This would mean that the whole lot is paid off in 7 years, woo hoo! , instead of 12. Over this seven years the total amount paid would be 90,720.

We could then bank the 1080 per month into a savings account, lets say at 5% again, over the following 5 years to bring up to our 12 year deadline. This would grow to a handsome 71,000

When the 12 years are up, the endowment matures & we can simply bank the proceeds of 57,800

So in this case, our net worth will be income (71,000+57,800) minus outgoings (90,720)….

Which is £38,080. Hang-on though, this is nowhere as good as option 1 ?!

Have I not worked this out correctly ? Have I missed something ? Or would I actually be better not paying the mortgage off earlier ??

If you’ve got to the end of this well done.
If you’ve understood it on the first read, or indeed the second or third, I’m well impressed.
If you can point out any errors I’ll be very very grateful indeed.

Thanks all, TP

bunking_off

Without going too far into the figures (because it makes my brain hurt), I think the simple comparison of which way to go depends on the return you can get on any investment versus the interest rate you make on any loan.

My figures may be wrong, but I *think* the numbers you quote indicate a mortgage interest rate of approx 4.8%. Think of it this way...you have a £1 coin. If you use that £1 to repay your mortgage, then you've effectively got a 4.8%/yr return out of it. Conversely, if you invest it in your "typical" investment, then you'll get 5% return. Clearly for these figures the latter is better (though I'm surprised the effect is quite so extreme...possibly a "time value of money" issue).

If the return on any investment is the same as the interest rate on the loan, then there's no obvious way forward. If you get a lower rate on investments than your loan interest rate, then better to pay the loan down. If you can get a higher rate on investments than you pay out on the loan, then it's better to invest.

However, I'd seriously query whether the figures you quote are achievable. Remember for the investment, you're talking post tax, so if you're a 40% tax payer that's 8.3% gross return unless it's in an ISA wrapper. Now, the return you get on paying down the mortgage is risk free - you know you'll get it. If you can point me in the direction of an investment that pays 8.3% gross guaranteed, I'd like to up my mortgage to invest in it...

tallpaulunderwood

Bunking_off,

I've found out where my figures have gone wrong. Where I've worked out my net worth from outgoings vs income, what I haven't done is include what I 'pay' as an outgoing into the savings accounts ! When I add these in, the figures end up much the same as each other.

You're right, the mortgage rate is 4.84% !

Savings at 5% (ING Dirct) is tax free due to my wife's non-working status (for now).

Thanks for the post, the numbers made my head hurt as well.

TP

bunking_off

Aha! Reading again I see where you missed the savings...easy with hindsight.

Believe it or not, I did come to a figure of 4.83-4.84%, but I rounded to 4.8 as 4.84 seemed such a strange figure!

As my wife works I can't use her as a tax shelter...keep quiet about that in case she gets any ideas...

JayS_3

Can either of you help me now, we are in a similar situation:

ie: 3 endowments and 1 repayment = one mortgage

By some miracle, our first endowment comes up this month and has done quite well, so we plan to use it to pay off a portion of the endowments, take some investments(from the stock market) and some savings (earning 4.5 to 5% interest, have been the non-tax paying wife but am returning to work and to paying tax).

Then pay the rest of the mortgage by repayment in an offsetting mortgage. Does this tally with your thoughts?

However, when we plug our details into the First Direct (4.99% for 18 months then 5.5% for next 18 months, no tie ins, unlimited overpayments, cheapish settup costs) Offset Mortgage calculator we get: you will reduce the terms of this mortgate by 1 year 8 months.

When we plug the same details into the One Account (5.95%) offset Mortgage calculator, we get: you will reduce the terms of this mortgage by 4 year and 2 months. and the One Account charges higher interest. (I'm confused now)

It does not seem to make sense to me, even allowing for the difference in the interest rates.

Can you help?

Regards
JayS

JayS_3

Okay, I think I've got my head around it now.

The One Account is not an offset mortgage, any lump sums aren't offset, but pay off a chunk of the mortgage therefore reducing the term by a chunk too.

The First Direct Account is an offset mortgage, any lump sums are offset, but stay in a separate account. Means when the product is no longer favourable, can move savings and mortgage debt elsewhere, thereby not loosing the savings.

I think...

JayS_3

By the way TallPaul, which option will you go with?

bunking_off

JayS

I'll take your word for it on having found out the reason for the difference....I've got a One Account so I don't know the ins & outs of Offset mortgages. Without knowing the outstanding (repayment & interest only), lump sum to be paid off & interest rate, it isn't possible to calculate the impact it'd have on the mortgage length, but assuming you've got a reasonable time to go and the amount you'd be paying off is significant, I'd be inclined to believe the One Account numbers (e.g. on a 100k repayment 5.85% mortage with 20 years to go, paying £10k off now and maintaining the repayments as was kicks 40 months off the repayment time, and saves an incredible £28K in repayments...albeit in 16 yrs time).

All I know for myself is that my rate's 5.85%, so whenever I've got a spare quid, the choice is between investing or paying my mortgage down. To make investment worthwhile, I have to clear 5.85% net return, which is 9.75% gross plus whatever premium I expect for investment risk. Let's face it, other than the rather nice SAYE scheme at work, that type of return isn't going to happen (though my William Hill shares did me rather nicely!).

One other nuance on the issue of whether to pay debt down or use endowment returns elsewhere...on the One Account the rate you pay is dependent upon the size of your FACILITY versus the value of your house (NB facility, NOT outstanding balance). It therefore makes sense if the mortgage is paid down, to reduce the size of one's facility unless you intend to make a large purchase in the future. Also, if it's a while since the mortgage was taken out, it makes sense to have the property revalued as that can have a reasonably short payback time.

JayS_3

Bunking_off

Thanks for your post, I'm taking it on board, but not quite sure what you mean by "FACILITY versus the value of the house"?

JayS

bunking_off

JayS

When you take out a One Account, you apply for a particular facility. So, for example, you may apply to borrow up to £140k on a £250k property (56% of value) - this is the FACILITY. Now, you may actually only need to borrow £110k, and have asked for a bigger facility e.g. to build an extension, leave future flexibility, buy a car or whatever. However, the interest rate applied by Virgin is based on the 56% facility against house value, not 44% (110k/250k) actual loan value. To put it in perspective, for 56% I *think* the interest rate is 5.95%, whereas it falls to 5.85% if your facility is <50% of the value of the property.

Put it another way, if you DID borrow right up to the facility, then gradually paid down your mortgage (either organically or by lump sums), the interest *rate* would be based on the facility versus house value, not your outstanding balance, ie the rate wouldn't change as you pay the mortage down, unless you requested that the facility be reduced : I think (NB *rate* - the actual interest is calculated based on your outstanding balance, it's just the rate that changes according to the size of the facility).

I'm sure I've not explained myself very well, but hope this makes some sense...

Paul

JayS_3

Paul

Thank you, I think ... but it's makes my brain hurt.

Many thanks

Jay