Overpayments versus term reduction

K-Lye

Hi - I have a question. We're regularly overpaying on our Nationwide mortgage but having browsed through this forum, a thought occured to me. Would reducing our term at the next renewal stage of our mortgage be a better approach than paying he overpayments?

I'm aware of the risks of having less flexibility but then we're fairly financially savvy so it's not a huge concern for us. In this case though, I'm not really sure how you'd calculate the difference. any ideas?

InMyDreams

K-Lye wrote:

I'm not really sure how you'd calculate the difference. any ideas?

Ultimately, there is no difference. Whatever you pay off each month will first go to clear the interest accrued (which is not related to how many years officially left, only the outstanding balance) and then anything over that will be taken off the capital. The only difference with reducing the term is that then you are then committed to paying a bit more off the capital than you were otherwise. Conversely, if you don't reduce the term with the overpayments, the regular payments reduce, which will slow down the rate at which you're paying off your capital so you have to keep up with the overpayments manually. I guess there's also a psycological boost in feeling like you are that bit closer.

There is no financial difference to calculate. But it might save you a few minutes each month arranging the overpayment. On the otherhand, if your 'overpayments' are set anyway, are you less likely to be bothered to make even larger overpayments in the months that you are able? Or will you struggle in leaner months?

IMD.

K-Lye

InMyDreams wrote:

Ultimately, there is no difference. Whatever you pay off each month will first go to clear the interest accrued (which is not related to how many years officially left, only the outstanding balance) and then anything over that will be taken off the capital. The only difference with reducing the term is that then you are then committed to paying a bit more off the capital than you were otherwise. Conversely, if you don't reduce the term with the overpayments, the regular payments reduce, which will slow down the rate at which you're paying off your capital so you have to keep up with the overpayments manually. I guess there's also a psycological boost in feeling like you are that bit closer.

There is no financial difference to calculate. But it might save you a few minutes each month arranging the overpayment. On the otherhand, if your 'overpayments' are set anyway, are you less likely to be bothered to make even larger overpayments in the months that you are able? Or will you struggle in leaner months?

IMD.

Hmm.. that's interesting. I've instructed them not to reduce our monthly payments at all so I know that I'm regularly paying X amount per month plus Y overpayment. It's affordable and we actually account for leaner months in other ways so there's very little chance of these payments being affected.

If what you say about either method being exactly the same is correct, then the only benefit I can come up with is that in shortening the term and thereby increasing our regular payments allows us the flexibility to overpay again on top of whatever we're paying on the shortened term (in the event of an unexpected windfall or something) :question:

pollyanna24

The thing with Nationwide is that you can only overpay up to £500 a month. If you find that you want to overpay more than this, then an option is to lower your term.

Personally I would be scared by this, but then I've just bought my house. We currently overpay by £115 a month and will continue to do so. If we find we can afford more, then we will pay more. If we find we are getting to the point of overpaying nearly £500 a month, I would conisder reducing the term, but not by much.

I like the security of knowing I can pay less if I want. That's why we took a 35 year mortgage instead of a 25 year one. We make the overpayments as if it were a 25 year mortgage just in case there are a few months where we can't afford it.

Admittedly you have to be pretty strict with yourself to make yourself make the overpayments, but I'm quite good like that.

There is no different in interest payments by reducing your term, but like someone said above, it would feel nice to feel that you're that little bit closer to paying the mortgage off if you reduce the term.

InMyDreams

K-Lye wrote:

If what you say about either method being exactly the same is correct, then the only benefit I can come up with is that in shortening the term and thereby increasing our regular payments allows us the flexibility to overpay again on top of whatever we're paying on the shortened term (in the event of an unexpected windfall or something) :question:

Not sure I follow, unless what Pollyanna says below applies, in that you are already topping up by the max amount, and the only way you could overpay more is if the regular payment was larger. Otherwise, I don't see how shortening the term can increase flexibility.

It's true, you need to check out how much or little you are allowed to overpay. I have the opposite problem, in that if I overpay, it must be by a *minimum* of £500, so for me, the larger the regular payment, the longer it will take me to save up the £500 minimum repayment.

(Although actually I don't overpay into my mortgage monthly anyway any more, I've set the repayments as low as possible and 'overpay' into a regular saver. When it matures in Jan I'll decide then whether to use the money to pay off a chunk of mortgage then, or whether to put it in an ISA to 'offset' the mortgage instead.)

pollyanna24

I assume that's what the OP means by flexibility. If you have over £500 to pay over your normal payment, Nationwide penalise you if you are on a fixed rate.

K-Lye

InMyDreams wrote:

Not sure I follow, unless what Pollyanna says below applies, in that you are already topping up by the max amount, and the only way you could overpay more is if the regular payment was larger. Otherwise, I don't see how shortening the term can increase flexibility.

Yes, perhaps 'flexibility' was the wrong word. I mean I'd have the option to overpay more than the £500 we're restricted to on this mortgage as pollyanna24 has pointed out.

It's interesting you're putting your money into a savings account. Do your calculations indicate you'd get a better return on this than ploughing it into your mortgage? Or is that simply because you're saving less than the minimum required overpayment on your mortgage?

pollyanna24 wrote:

Admittedly you have to be pretty strict with yourself to make yourself make the overpayments, but I'm quite good like that.

Yea, we're pretty strict too hence I'm not so worried about our money being tied into the repayments. So in conclusion, it's fairly simple - don't bother unless it's likely we're going to overpay by more than £500 as either option is exactly the same. Thanks! :cool:

InMyDreams

K-Lye wrote:

It's interesting you're putting your money into a savings account. Do your calculations indicate you'd get a better return on this than ploughing it into your mortgage?

Basically, yes.

We were looking to overpay by about £250/month (although actually that only brings us in line with what a repayment mortgage would cost us as at the moment it's mostly interest only, so strictly not even an 'overpayment' really). As I stated above, we'd have to keep the money somewhere until we reached the £500 minimum 'overpayment' anyway.

The calculations are very simple for us because I'm a non tax-payer (currently at home with three small children). So interest above the rate of our mortgage is pure profit. If you actually want to look at the figures, paying the £250 into my A&L 10% regular saver will net us the full £160 interest. (It's not drip fed from a savings account so I'm not including any extra interest, but then I'm not paying tax on it either.) Our mortgage is 5.3%, so if we ploughed the money in there, we'd save only £85 in interest. Actually less, as half the payments would have to hang around for a month untill we reached £500. So by the end of the year we're at least £75 up. So at the end of the year, that's a 'free' £75 overpayment if we want to do it like that.

Actually, what I want to do in Jan when the saver matures, is set up a two regular savers, and a 'pot' with the proceeds of this year's efforts, drip feeding one saver from the pot and putting our £250/month 'overpayments' into the other just as this year. Anything we can afford above that can go into the pot too. What I'm aiming for is to (maybe by the year after) start opening some isa's in both our names. Even if the interest rates on those only balance the mortgage (so no overall financial saving/cost), I'd rather the money to be in an isa than in the mortgage because a) it would be easier to get at than a remortgage should we need/want to and b) the isa's are 'use it or loose it' and I envisage/hope that at some point in the not-too-distant future, I won't be a non-tax payer any more! If we didn't do things like this at the moment, then on one (modest) salary for a family of five, we would never get to take advantage of isa's for a good few years to come, by which time it might be too late.

Hopefully, by the time we actually have to repay the mortage, we won't have to use *everything* we've saved (at least not the isa's), but if we do, it's there. I don't want to wait until we've paid of the mortgage to start building up the isa's (or whatever equivalent there might or might not be by then).

IMD.

(PS I've used this interest checker to work out the figures.)

K-Lye

InMyDreams wrote:

If you actually want to look at the figures, paying the £250 into my A&L 10% regular saver will net us the full £160 interest.

Wow.. 10%? Even paying tax, that must still work out worthwhile doing. Is that something you got off MSE because I've obviously missed that trick!

InMyDreams

K-Lye wrote:

Wow.. 10%? Even paying tax, that must still work out worthwhile doing. Is that something you got off MSE because I've obviously missed that trick!

Well, it's now paying 12% actually, but I took mine out when it was still 10%. There are a few conditions (mainly that you need to be a new current account customer, I think, and you have to open a current account with them and pay in £500/month, but it doesn't have to be your salary. I opened it and just route my mortgage payment through them, plus the £250 to go into the saver.)

Anyway, there are also cash incentives to sign up on top, so go to the referal board to find someone else with an account, pm them and you'll net another £50 for doing so (as will they, but I think the ettiquette is for them to send some of their £50 on to you too, so I'm not sure what the 'going rate' is now).

http://www.alliance-leicester.co.uk/savings/index.asp?page=prem-regular-saver&ct=savingshome

IMD

K-Lye

InMyDreams wrote:

Well, it's now paying 12% actually, but I took mine out when it was still 10%. There are a few conditions (mainly that you need to be a new current account customer, I think, and you have to open a current account with them and pay in £500/month, but it doesn't have to be your salary. I opened it and just route my mortgage payment through them, plus the £250 to go into the saver.)

Anyway, there are also cash incentives to sign up on top, so go to the referal board to find someone else with an account, pm them and you'll net another £50 for doing so (as will they, but I think the ettiquette is for them to send some of their £50 on to you too, so I'm not sure what the 'going rate' is now).

http://www.alliance-leicester.co.uk/savings/index.asp?page=prem-regular-saver&ct=savingshome

IMD

I love the idea of this account, but I've been trying to work the figures on this :mad:. Isn't it the case that when you overpay on your mortgage the money comes directly off the capital and hence reducing the overall interest charged. In a sense, the savings you make in terms of interest are spread across the full term of your mortgage unlikely a savings account which gives you interest only on the monies you invest? Or am I completely off base here? :question: