Help with some mortgage sums needed please!

Oggy_3

Can someone help me here. I have being the sums on this little teaser but I can't work out the answers.

Ok- here's the situation:

I have a £67,000 mortgage that I took out in June 2003.

It has a term for 10 years. It is repayment (ie capital + interest).

I have 3 years fixed at whatever - therefore I am just ober a year into the 3 year fix.

I pay about £700 each month. I have made no over payments so far.

Now I have just inherited about £70,000 but I may not actually get the money for another year.

My question is this - I can afford to make regular overpayments (my BS will allow up to £500 each month).
- should I actually make any overpayments or should I just wait until the fixed term is up (another 2 years or so) and pay off the mortgage then?

Also if I get the money in the next year should I pay the redemption penalty - is it cheaper than paying another years worth of mortgage? And either way should I keep making overpayments?

I suppose the overall question is - Is it cheaper in the long run always to make overpayments when you can - even though you know you will be able to pay the whole thing off in about 18 months anyway? Would those overpayments have been wasted (18 x £500 is a lot of money)?

Sorry for the essay but I would appreciate some help?

dunstonh

It all depends on the size of the redemption penalty. You should be aware that making overpayments now will also incur penalties.

Oggy_3

I can make £500 over payments each month without any penalty.

I am right in thinking though that 18 payments of 500 (which is £9000) will not knock off £9000 off the amount when I come to pay off the full outstanding amount when I get my inheritance?

lisyloo

I am right in thinking though that 18 payments of 500 (which is £9000) will not knock off £9000 off the amount when I come to pay off the full outstanding amount when I get my inheritance?

No it isn't right because you haven't included interest so it will be more than £9000 (assuming you keep your payments the same).

Paying off your mortgage is a really good idea because
1) get a good return (your mortgage rate)
2) You pay no tax on that return
3) It is guaranteed (not like shares where it varies and you can even loose money).

should I actually make any overpayments or should I just wait until the fixed term is up (another 2 years or so) and pay off the mortgage then?

As explained above, paying off your mortgage is a great idea, but there are a few caveats
1) Do you have enough emergency money in available cash. You should keep an amount of money in available cash ready for emergencies such as car crash, redundnacy, roof falls in etc.
How much you need varies but 3 months living expenses sounds good to me if for exmaple you were out of work for 3 months.
This money can be in an ISA (tax free) but should be accessible e.g. not equity in a house.
2) Are other area of your finances in order.
For exmaple have you got a pensions that has a good level of contributions going into it. You can get tax relief on pension contributions so it's also a good area to put money into.

Also if I get the money in the next year should I pay the redemption penalty - is it cheaper than paying another years worth of mortgage?

This is where you would need to do some more detailed sums. The answer is probably that it isn't worth paying the redemption penalty but we'd need more details to work it out.
Can you supply the following information.
Mortgage rate.
Your tax rate.
Size of penalty.
Date penalty ends.

And either way should I keep making overpayments?

Speaking very generally (as I don't know your full situation).
If you have emergency cash already available and a well funded pensions then you should probably only make overpayments that don't invoke a penalty.

Is it cheaper in the long run always to make overpayments when you can

In general if you are a tax payer, then it's the best risk free return you can get.
You might be able to make more from shares etc. but that's not risk free and you could lose money.

even though you know you will be able to pay the whole thing off in about 18 months anyway?

I think that's pretty much irrelevant.
Personally I wouldn't change my decisions on the basis of this inheritance (just in case something goes wrong like someone challenges the will).

Would those overpayments have been wasted (18 x £500 is a lot of money)?

There is no way the overpayments will have been wasted.
They will come off your loan.
All it will mean is that when you inherit, you will have an extra £9K (plus interest) in your pocket.
All you are doing is investing that £9K in the best way possible in the meantime.

Hope that helps

Mortgageman

brilliant post Lisyloo

DiggingOut

Oggy, your mortgage sounds like it is from the same lender as mine, so I suspect your penalty for paying off the mortgage is 1/12 of 1% for each month remaining in the penalty period. Is that correct?

Also, as lisyloo says, to do the sums you have to consider your current mortgage rate and whether you are a basic rate or higher rate taxpayer.

Also, options are available if you are married and your spouse is not a taxpayer, or if you are higher rate but your spouse is basic rate.

Basically, the question comes down to whether or not you will get a better return by paying off the mortgage entirely, including penalties, by making overpayments until the penalty ends and then paying it off, or by just waiting until the penalty period ends.

The answer depends entirely upon effective rate of return.

The simplest case is overpayments that do not trigger a penalty. Let's assume that you make an overpayment of £100. If you have a mortgage rate of 5%, you will have saved £5 of interest at the end of the year, and you will owe £100 less on your mortgage.

Alternatively, you could put that £100 in savings, and you might be able to get 5.5% interest on it. That would be £5.50 you would have gained, but the taxman wants his share (£1.10 if basic rate, £2.20 if higher rate). If you have a spouse that doesn't pay tax, you can thwart the tax man and put the savings in your spouse's name -- and you get all £5.50.

Under the savings scenario, you owe £100 more on your mortgage than you would if you made an overpayment, but have £100 in savings, so that balances out -- but the interest you gain is different from the £5 you saved with the overpayment. It is either more or less, depending on the savings rate and taxes.

With paying off a mortgage during a penalty period, it is more complicated than just comparing mortgage rates and after-tax savings rates, because you have the cost of the penalty to consider and the fact that the penalty is paid up front, at the time of pay-off. It may be a matter of spreadsheet work to determine precisely the cutoff point where it makes sense to pay it off, but if you post the above details as far as rates and taxes we can give you a pretty good estimate.

Oggy_3

Thanks for all you replies so far. I think I am starting to get my head around this.

Here is some more info.

Mortgage rate is 4.09% fixed until May 2006. Then SVR.

I am a higher tax rate payer. My partner (unmarried( is a basic tax rate payer.

The redemption rates for my mortgage are:
For a 3 year fix it is 2% if paid off during Year 2 and 1% if paid off during Year 3. Penalties end after May 2006 when the fix ends.

I can deffo make £500 overpayments each month with out penalty.

Thanks again and I hope the info is useful!

lisyloo

Ok, the fact that you are not married is a disadvantage.
Spouses can give money to each other completely tax free and hence if you were married you could put all your savings in your spouses name and pay the lower rate of tax.
However as you are unmarried there are all sorts of complications with tax and also if one of you dies or you split up.

Basically because you pay higher rate tax then you won't get a better net rate than 4.09%. So certainly your mortgage will be the best best.
This is because you'll have to pay 40% tax on any interest from  savings accounts you have (outside of ISAs).

Another possibility to consider (as mentioned before) is pension contributions.
You will get 40% tax relief on your contributions.
ie.. If you pay £60 into your pension the government will add another £40.

This is something you should consider, but it's impossible to say what you should do because we don't know anything about your existing pension arrangements.
It is certainly worth considering though.

Another thing to consider if you are with your partner long term is.....marriage.
In financial terms there are big benefits to getting married.
For example an unmarried spouse has no inheritance rights if there is no will left.
People tend to only find out the problems when something bad happens like death - but it can be disastrous.

Oggy_3

Thanks again.

Just a quick question. I have only become a higher rate tax payer last year. How do all the bamks that I have accounts with know this so they can deduct more tax from my savings?
Also will this tax be deducted from all my savings from now on? It seems a bit unfair cos I only pay 40% on a part of my salary but ALL of my savings?!

lisyloo

How do all the bamks that I have accounts with know this so they can deduct more tax from my savings?

The banks don't know and they won't do it for you.
When you get into the 40% tax bracket you have to fill out a tax return and work it out for yourself.
If you became a 40% tax payer in the tax year April 2003 - April 2004 then you should get onto your tax office ASAP and ask them to send you a tax return.
(There are time limits and you get fined if you don't do it on time).

The good news is that if you have a pensions then you are probably owed money (because of the tax relief I mentioned earlier).

Also will this tax be deducted from all my savings from now on? It seems a bit unfair cos I only pay 40% on a part of my salary but ALL of my savings?!

Yes, you will have to pay it on ALL your savings (except those in an ISA).
It is not unfair.
There are bands for income tax. There is a 0% band, 10% band, 22% band and then everything else is 40%.
You have FULLY used already your 0%, 10% and 22% bands so everything else on top is now 40%.
You cannot reuse those bands.

As stated above, you can use this to your advantage and claim back tax on your pension.
You should also make use of ISA allowances.
You could also consider getting married
(only kidding - I wouldn't suggest it for purely financial reasons).

Oggy_3

You have got me a bit worried about the tax thing.

Between april 03 and april 04 I probably didn't make more than £33k (so not higher ?)?

However I start a new position in September (I am a teacher) and will probably make about 40k from Sep thru to Aug. Within tax year april 04 to April 05 i should deffo be in upper bracket then.

How do you actually find out when you are bring taxed in the 40% range? I have no indication at all that I have yet been.

Dont teachers do PAYE anyway so I should never have to do a rax return?

And as for pensions - as a teacher I have been paying into one for about 10 years but with no AVCs.