Mathematician required

mary

jamesd wrote:

A 6% penalty is less than the cost of not making the early repayment, since you pay 4.98% in the first year and again in each subsequent year, plus compounding on the interest paid. You're ahead within about 16 months even after paying the penalty. QUOTE]

I'm not sure I follow.
Supposing on day 2, for argument's sake, you repay the whole lot, the 6% penalty is £3,600.
The savings in interest using David's calculations amounts to £3,271.90.
So the 6% penalty is more, not less.

Whilst the saving in interest is not huge, the point that affects us, is that in 4 years time, my husband will be age 65 and we will take a sizeable drop in income, so to lessen the outgoings was the object of the exercise.

I can see that under normal circumstances it would be better to keep any overpayment money in higher interest rate accounts, but who knows what they will be in 10 years time!

david78

mary wrote:

jamesd wrote:

Supposing on day 2, for argument's sake, you repay the whole lot, the 6% penalty is £3,600. The savings in interest using David's calculations amounts to £3,271.90. So the 6% penalty is more, not less.

Actually, if you pay the lot off on day 2, it would cost you £3600 but you would save £16,296.80 interest. So it would be worth doing it. But this is an academic example. A better argument for not paying it off early is:

The overpayment schedule will lead to savings of £3271.90 if carried out to its end. If you want to do better by switching to another mortgage, you will need to (a) pay the early repayment fee of £3600, and (b) find a mortgage deal where the interest is less than £16,296.80-£3600-£3271.90 = 9424.90. My mortgage calculator shows this is equivalent to a fixed interest rate of 2.97%, a bit of a tall order. (Plug this into any calculator on the web to see).

jamesd

3271 is the saving if you pay it gradually, not if you pay it all at once. Say you pay 1000 extra at the start of year 2 and use the interest saved on that to pay off a bit more of the mortgage.

You pay 6% of 1000 = 60.
Year 2 you save 4.98% of 1000 = 49.80, 46.82 after 6%
Year 3 you save 4.98% of 1046.82 = 52.13, 49.00 after 6%
Year 4 you save 4.98% of 1095.82 = 54.57, 51.29 after 6%
Year 5 you save 4.98% of 1147.11 = 57.12, 54.83 after 6%
Year 6 you save 4.98% of 1201.94 = 58.86, 56.26 after 6%
Year 7 you start with 1258.20 paid off.

This continues to the end but at this point you paid 60 initially and have already saved 258.20, so you're ahead by about 200 pounds.

Instead of making that extra overpayment today you could save it in regular saver or ISA accounts and that would make you a bit more better off, then you could pay it off the mortgage when your husband retires, to reduce the outgoings at that point. Because the interest rate is higher you'd have that much more to use to pay it off. But instead you could use the interest from the savings to reduce the net monthly outgoings, by taking the interest to pay part of the monthly mortgage amount. That would leave you better off than paying the money off the mortgage.

It stops being worthwhile to pay off more than the 5% allowance about 1.5 years from the end of the mortgage. At that point the 6% penalty becomes greater than the interest saved. But before that it's really better to save and then use the interest on the savings to reduce the net outgoings.

If the interest rates on savings do fall below the mortgage interest rate, and it's more than18 months from the end of the mortgage, you can just use all of the savings money as a mortgage overpayment.

Edit: I see David gave the revised calculation if you paid it off all at once. He and I seem to be agreeing.

david78

mrcow wrote:

Hi David, would it not be better for the OP to use the overpayment to reduce the term though? Rather than sticking to the original ten year plan? Or is this not possible?

I just love the avatar mrcow.

Generally, if you are going to take out one of these mortgages you should go for the shortest term you can afford, and not overpay. This will save you the most interest. With this method though the payments you make will not decrease over the years.

As Mary has already taken her mortgage out over 10 years, opting for a shorter period is not possible (now). But at least with overpayments of 5% she will achieve decreasing payments, which should help when her husband retires.

david78

jamesd,

I don't get your table. The 6% penalty is on the amount overpaid, not on the amount of interest saved. Perhaps its just me ad the lateness of the hour! But I agree with your reasoning with regards to the use of ISAs. It just needs more willpower to do it that way.

jamesd

David, there are two sets of 6%. First on the initial 1000, then again on each bit of interest saved each year as that saved interest is also used to overpay.

david78

Oh I see what you are doing.

But I don't think you should apply the 6% penalty on the interest saved in successive years. If you pay £1000 in year 1 there will be a penalty of £60 which will be deducted from the payment, so the mortgage will be credited with £940. You will then save interest in the following years equivalent to the interest made on £940 at 4.98%. Over 7 years the interest saved (allowing for compunding) would be approximately 940*((1+0.0498)^7 - 1) or £381. (more than your £258 figure).

So the upshot is that overpayments above 5% made in the earlier years can be recouped in interest saved in future years, but they are not worth doing in later years.