Reduce term or monthly payments

jnb_2

If I make overpayments against a mortgage is it better to reduce the term or the monthly payments?

My mortgage provider seems to use a default of reducing the term. My previous mortgage provider used a default of reducing the monthly payment.

Now it seems to me that it's better to reduce the monthly payment on the basis that;

- It's still a capital reduction so the term is effectively reduced in that it would take me less to pay it off outright
- If money gets tighter it gives me more leeway
- If money doesn't get tighter I can still choose to make an overpayment
- If money gets really tight I have a credit facility which means I can defer a few mortgage payments.

So why would I choose to reduce the term?

ViolaLass

jnb wrote: »

- It's still a capital reduction so the term is effectively reduced in that it would take me less to pay it off outright

How do you propose to pay the mortgage off sooner if you reduce your monthly payments? Sure, your overpayment will mean that you owe less but if you reduce the payment and not the term, it will, by definition, take you just as long as before to pay off, you'll just pay less each month.

However, your point that keeping the term the same and reducing the payment allows you to make overpayments of how much and when you wantis correct subject to the terms of your mortgage which may well limit what overpayments you can make.

ReadingTim

Reducing the term reduces your risk to future events (for example a rise in interest rates) which you have no control over - for example, in the case of a standard variable rate mortgage over 25 years, overpayments to reduce the term could repay it in 20 years. Overpayments to reduce the monthly amount would still take 25 years.

However, imagine if interest rates shot up dramatically in year 21 of the mortgage - if you'd overpaid to reduce the term, this wouldn't affect you. If you overpaid to reduce the monthly amount, it would; and your monthly repayments would rise with interest rates.

Why wouldn't you do this?

Less hypothetically, I made the maximum overpayment I could on my mortgage when I was tied into the introductory fixed rate - £500 per month. Spread over 30 years, borrowing £140k, reducing the monthly amount knocked off a few pence off a monthly repayment of £737.35. Hardly motivational, yet reducing the term knocked off a couple of months off the repayment date, per overpayment; which is considerably more motivational! Was a few pennies now worth over a grand, even 30 years later?!? I doubt it!

jnb_2

ViolaLass wrote: »

How do you propose to pay the mortgage off sooner if you reduce your monthly payments? Sure, your overpayment will mean that you owe less but if you reduce the payment and not the term, it will, by definition, take you just as long as before to pay off, you'll just pay less each month.

Except that as it's still a capital repayment then at some point I can just pay off the outstanding mortgage in full.

If I have a 100k mortgage and overpay 5k then the capital is down to 95k. Now I can either reduce my monthly payment by about 5% or pay the same and reduce the term. If interest rates rise it's a rise on a now reduced capital so it has less effect than it would have and if I keep repeating the exercise then eventually I get to the point where my mortgage is for a trivial capital sum and I can just pay the whole thing off, e.g. if in 10 years of doing that I've got a mortgage which is by then for £10k but with 15 years to run then at that point I can probably just pay off the whole mortgage there and then. Looked at that way then ither approach is reducing the term, it's just that reduced monthly payments leave me in more control.

Or have I fundamentally misunderstood something here?

getmore4less

ReadingTim wrote: »

Reducing the term reduces your risk to future events (for example a rise in interest rates) which you have no control over - .........

It actualy increases the risks associated with reduced income since you may be unable to reduce the payments in the future, since you have no rights to increase the term back to its original term.

The term is reduced by paying/saving faster than the schedure requires and this can still be acheived with reduced payments you just increase the overpayments by the reduction in the payments.

The only problem is if your product has penalties for overpayments.

Shortening term should also be considered as part of long term plans savings/investements especialy if future savings once the mortgage is finished will exceed the ISA allowances.

ReadingTim

getmore4less - sorry, I may have been thinking only about my mortgage. Overpayments are held in a seperate reserve, which is used (in my circumstances) to reduce the term. However, they can also be "borrowed back" to fund payment holidays, or other things, whereupon the term is adjusted accordingly. I guess if I borrowed all my overpayments back, my term would revert to the original repayment date.

However, you may be thinking about additional repayments, rather than overpayments - overpayments can usually be borrowed back, repayments cannot.

I think all this illustrates is how mortgage products differ greatly, and you need to read the T&Cs carefully and understand all possible charges before you can come to a decision - the OP would need to give all those details before anyone can properly help him/her

ViolaLass

jnb wrote: »

Except that as it's still a capital repayment then at some point I can just pay off the outstanding mortgage in full.

I don't understand what you mean here about it being a 'capital repayment'. Of course, you can always pay your mortgage off in full, subject to fees and conditions, but assuming you have a secure job, adequate savings and your mortgage rate is higher than your savings rate, then it would save you more to pay in a higher amount every month, rather than sporadic lump sums, because the earlier you reduce the capital, the less interest you end up paying.

If I have a 100k mortgage and overpay 5k then the capital is down to 95k. Now I can either reduce my monthly payment by about 5% or pay the same and reduce the term. If interest rates rise it's a rise on a now reduced capital so it has less effect than it would have and if I keep repeating the exercise then eventually I get to the point where my mortgage is for a trivial capital sum and I can just pay the whole thing off, e.g. if in 10 years of doing that I've got a mortgage which is by then for £10k but with 15 years to run then at that point I can probably just pay off the whole mortgage there and then. Looked at that way then ither approach is reducing the term, it's just that reduced monthly payments leave me in more control.

That's true although you haven't acknowledged my earlier caveat which is that the benefits of overpayments are subject to the conditions of your mortgage, for example, the bank may only let you overpay 10% each year or may charge you a fee for each overpayment. You need to examine the terms and conditions of your own mortgage to know the answer to this.

Or have I fundamentally misunderstood something here?

Not misunderstood, just omitted.