mortgage overpayment - capital or term reduction?

twirlypinky

Hi,

My boyf and i are about to start overpaying his mortgage to clear the negative equity so we can sell up and get out.

I mentioned this at work and a colleague that used to work in a bank warned me that we might not be reducing the capital, simply reducing the term.

Anyone know which it is?

Thanks

TP

mynameisdave

I can only see it being overpaying. If you pay more than you need it is subtracted from the figure you pay interest on.

Therefore your loan decreases.

However, I'm not an expert so don't take that as gospel.

BitterAndTwisted

The way I see it is should you remain in the property, continue over-paying the mortgage and never sell then you would in effect be reducing the term of the mortgage but once you come to sell you've reduced the capital sum outstanding.

But I'm not a mortgage-payer, so what do I know?

twirlypinky

So both then in a way?

sonastin

Assuming it is a repayment mortgage...

If you go with "term reduction", your usual payment will stay the same and the length of time to pay the mortgage off will be reduced - the overpayment reduces the amount that interest is charged on, so your repayment sum is more capital and less interest.

The alternative overpayment response is that your monthly payment is reduced by the amount of interest that you no longer need to pay on the overpayment amount.

If your overpayment amount each month is limited, make sure that your normal monthly payment stays the same so that you can pay off as much capital as you can without incurring penalties. (although the penalties can be less than the interest so might be worth doing some sums on that if you have the additional cash to put into the mortgage)

twirlypinky

No, it's interest only, that's why we're overpaying it. We're in negative equity and the mortgage lender weren't interested in giving us a repayment deal when we went in in June.

mynameisdave

Then I don't see how you can be reducing your term.

At the end of the mortgage (probably 25 years) you have to pay whatever you owe. By overpaying you are reducing this figure.

DVardysShadow

twirlypinky wrote: »

Hi,

My boyf and i are about to start overpaying his mortgage to clear the negative equity so we can sell up and get out.

I mentioned this at work and a colleague that used to work in a bank warned me that we might not be reducing the capital, simply reducing the term.

Anyone know which it is?

Thanks

TP

The colleague is a bit mistaken. If you overpay, you will inevitably reduce the principal [= capital]. Your colleague is mixing up what happens if you make a single overpayment - sometimes the lender keeps the repayment the same which reduces the term, some reduce subsequent repayments to maintain the same term. Inevitably, whichever the lender does, some customers want the other option, so if it is important to you you need to agree with the lender how they will adjust after overpayment.

In your case it makes no difference

pardal51

twirlypinky wrote: »

No, it's interest only, that's why we're overpaying it. We're in negative equity and the mortgage lender weren't interested in giving us a repayment deal when we went in in June.

If it is interest only, the overpayment will reduce the amount of interest you pay. Therefore it will reduce the term (interest only). However at the end of the loan period you still have to pay the capital borrowed. This is my understanding.

twirlypinky

pardal51 wrote: »

If it is interest only, the overpayment will reduce the amount of interest you pay. Therefore it will reduce the term (interest only). However at the end of the loan period you still have to pay the capital borrowed. This is my understanding.

So this is in contradiction to the other responses - are you saying that it won't reduce the capital?

I guess I need to contact the bank then!

Thanks

loracan1

pardal51 wrote: »

If it is interest only, the overpayment will reduce the amount of interest you pay. Therefore it will reduce the term (interest only). However at the end of the loan period you still have to pay the capital borrowed. This is my understanding.

An overpayment reducing the amount of interest you pay? The interest is calculated on a regular basis be it daily, monthly or annually. I've always understood that overpayments on an IO mortgage will only ever repay the capital.