Which mortgage to pay off first ?

Kelvin_Hall

Hi,

I have two mortgages with the same bank. Both are variable rate and have the same interest rate (2.49%). One is a repayment (approx £43,000) and one interest only (approx 29,000). Both mortgages have the same term of about 15yrs to go.

I have been saving to pay off the interest only mortgage at it's term, but have just found that I can make overpayments to either mortgage without charge.

Would it be better to pay overpayments to one of the mortgages or save the same amount of money (approx £100 a month) in an S&S tracker ISA? I'm a higher rate taxpayer (just).

And if so, would I be better to overpay to the interest only mortgage or the repayment one or does it not make a difference ?

Thanks in advance for any advice or help.

dimbo61

Well you know that the repayment part will be paid off in 15 years.
You HOPE the S&S ISA,s will grow in value enough to pay off the IO part.
Cash ISA,s are paying 3%+ at the moment so I would save in them or overpay the IO part.

Kelvin_Hall

Thanks for that Dimbo. I have decided to make overpayments to one of the mortgages as I can set that up and forget about it rather than worry if I am in the best cash ISA all the time.

The only decision, now, is whether it is advantageous to overpay the repayment mortgage, get it paid off, about 5 years early, then put the money I've been paying into that mortgage (regular payment and overpayment) into overpaying the IO mortgage OR make the overpayment to the IO mortgage now and pay off most of it before repayment time.

After I wrote the post above, I did some calculations which seemed to show that it made no difference which way I do it, but I'd really like confirmation from someone with a little more experience of finacial matters as I'm not 100% sure of my maths.

dimbo61

You are on a very good interest rate at the moment !
Is this a tracker rate ?
Many lenders are now asking that you have a suitable repayment vehicle for the IO part of your mortgage or they will transfer you on to a full repayment mortgage.

kidmugsy

If your mortgage is tracking 1.99% p.a. above Bank of England base rate, why not see if there's an ISA available that tracks at a larger margin above base? (The Cambridge BS offered one recently - perhaps someone else still does.)

jamesd

Are you already using the 8% regular saver for up to £300 a month that First Direct offers? It's clear that repaying any of the mortgages is going to make you worse off because you can earn more interest than you can avoid paying but that particular rate makes it even more obvious.

If you must make a choice, do the repayment one in preference to the interest only one. This is because the interest only one gives you flexibility to set any payment level from interest to repayment and higher, while the repayment one has less flexibility.

If you will be aged 55 or older when the mortgage terms end it's going to make you even more worse off than you might otherwise be because you'll be giving up the ability to get pension tax relief on your mortgage capital payments. You do this by taking some pension benefits at age 55 and using the tax free lump sum to do a lump sum mortgage payment. It's particularly beneficial for higher rate tax payers or those using salary sacrifice but it's a good deal for anyone who wants both a pension and a mortgage paid, if they are old enough.

You clearly have a suitable repayment strategy for your interest only mortgage in the form of your regular S&S ISA contributions. You may also have a pension lump sum available as part of the repayment strategy. Repayment strategy is the new term for what used to be called repayment vehicle before the Mortgage Market Review (details). You don't need just one vehicle, any combined or single strategy that is credible will do.

There is one substantial cost that you may incur as a result of making extra payments on the mortgages. The Mortgage Market Review requires advice in many cases where the amount borrowed increases but not if it is no higher. Porting when moving home is one of the cases where advice is not required if the amount doesn't increase. So if you might move to a higher value place you could be setting yourself up for a substantially higher cost by overpaying. Be sure you factor this risk into your cost calculations. This is table 2 in section 2.18 on page 14/15.

Kelvin_Hall

dimbo61 wrote: »

You are on a very good interest rate at the moment !
Is this a tracker rate ?
Many lenders are now asking that you have a suitable repayment vehicle for the IO part of your mortgage or they will transfer you on to a full repayment mortgage.

Hi Dimbo, Yes it is an excellent rate (though there was a substantial booking fee) and, after looking at my documentation, it is a tracker at 1.99% above Bank of England base rate. Spent a lot of time a few years ago, finding the best that was available as, at that time I needed to build an extension on the house but couldn't really afford it. So there was a lot of juggling money involved - hence the IO mortgage!

Kelvin_Hall

kidmugsy wrote: »

If your mortgage is tracking 1.99% p.a. above Bank of England base rate, why not see if there's an ISA available that tracks at a larger margin above base? (The Cambridge BS offered one recently - perhaps someone else still does.)

Hi Kidmugsy,
Thanks for the advice, but if the ISA your talking about is a cash one then I'd rather not use it as what I'm looking for is a long term solution which I don't need to review every year but can just work away in the background.

Kelvin_Hall

jamesd wrote: »

Are you already using the 8% regular saver for up to £300 a month that First Direct offers? It's clear that repaying any of the mortgages is going to make you worse off because you can earn more interest than you can avoid paying but that particular rate makes it even more obvious.

If you must make a choice, do the repayment one in preference to the interest only one. This is because the interest only one gives you flexibility to set any payment level from interest to repayment and higher, while the repayment one has less flexibility.

If you will be aged 55 or older when the mortgage terms end it's going to make you even more worse off than you might otherwise be because you'll be giving up the ability to get pension tax relief on your mortgage capital payments. You do this by taking some pension benefits at age 55 and using the tax free lump sum to do a lump sum mortgage payment. It's particularly beneficial for higher rate tax payers or those using salary sacrifice but it's a good deal for anyone who wants both a pension and a mortgage paid, if they are old enough.

You clearly have a suitable repayment strategy for your interest only mortgage in the form of your regular S&S ISA contributions. You may also have a pension lump sum available as part of the repayment strategy. Repayment strategy is the new term for what used to be called repayment vehicle before the Mortgage Market Review (details). You don't need just one vehicle, any combined or single strategy that is credible will do.

There is one substantial cost that you may incur as a result of making extra payments on the mortgages. The Mortgage Market Review requires advice in many cases where the amount borrowed increases but not if it is no higher. Porting when moving home is one of the cases where advice is not required if the amount doesn't increase. So if you might move to a higher value place you could be setting yourself up for a substantially higher cost by overpaying. Be sure you factor this risk into your cost calculations. This is table 2 in section 2.18 on page 14/15.

Wow James,

Thanks so much for taking the time to give me such long and detailed help, I really appreciate it.

As it happens, I did use the First Direct 8% regular payment saver for the first year (now well through the second year of these mortgages) but was unsure what to do with the cash accumulated in the saver account after the first year so started a S&S ISA after that to continue saving.
Even then, from what I have read (or miss-read?) I understood that as it is a regular saver it equates to 4% over the year (?). According to the calculator in martin's "Should I Repay my Mortgage?" info. As a higher rate tax payer I would need to get 4.2% to make saving more effective than repaying. Though, to be honest - I really don't understand how being (just) in the higher tax band affects this ! Also I worry that the a mid year rise in interest rates (must happen sometime) will wipe out any benefit I there was from this account.

The pension thing you described is completely new to me and very interesting (thanks). I am fast coming up on 50 and so it is definitely something to think about. Is my interpretation of what you said correct if I say that - I could do take some pension money as a lump some at 55, pay off part or all of the mortgages and then use the money saved, that I was paying into the mortgages, to pay more pensions contributions to get my pension back to where it was ?

As to your last point, the mortgage was increased to build an extension, so there is no chance of us moving to a bigger home. The next step is down the way, once the kids move out (5 to 10 years probably).

Thanks again for such an extensive response to my post.

JimmyTheWig

Kelvin_Hall wrote: »

what I'm looking for is a long term solution which I don't need to review every year but can just work away in the background.

I think that's fair enough.
You accept that there are other better solutions from a pure money point of view, but you want a solution that requires minimum work. That's a perfectly valid choice, though you will get people on here with different suggestions that don't fit this choice!

The golden rule is to pay off debts with the highest interest rate first.
In your case the interest rates are the same, so makes little difference.

Are we talking two properties or just the one? (I'm guessing one as you mention an extension, but if not the relative LTVs might come in to play.)
How long do you have the 1.99%+base rate deal for? Is it the same in both cases? (If not the same, then pay off the loan that reverts to a higher rate sooner.)
Would you feel happier if there was only one loan? (If so, pay off the smaller of the two loans.)
Do you like the surity of the money going out of the bank each month to clear the repayment loan? (In which case pay off the interest only loan.) Or do you prefer the flexibility of the interest-only loan where your capital repayments can fluctuate? (In which case pay off the repayment loan.)

But basically, it doesn't matter which you pay off.

JimmyTheWig

Kelvin_Hall wrote: »

As it happens, I did use the First Direct 8% regular payment saver for the first year (now well through the second year of these mortgages) but was unsure what to do with the cash accumulated in the saver account after the first year so started a S&S ISA after that to continue saving.

When the regular saver ended you could put the money into an ISA (cash or S&S, depending on your attitude to risk) or pay it off your mortgage (if you don't want to keep on top of your ISA to ensure it is doing what you want).

Even then, from what I have read (or miss-read?) I understood that as it is a regular saver it equates to 4% over the year (?).

Mis-read! You get around 4% of the final balance in the account. But on average the balance has only been half this, so you get 8% over the year on average.
As you didn't have the money until you were paid each month, this really is the equivalent of 8% (pre-tax) for you.

According to the calculator in martin's "Should I Repay my Mortgage?" info. As a higher rate tax payer I would need to get 4.2% to make saving more effective than repaying. Though, to be honest - I really don't understand how being (just) in the higher tax band affects this !

You pay tax on savings at your highest level. So if you earn £100 interest you pay £40 of that in tax, as a high rate tax payer. I.e. you only see £60 of it.
But 8% from the regular saver beats 4.2%, so if you wanted the hassle the regular saver would be more effective for you.

Also I worry that the a mid year rise in interest rates (must happen sometime) will wipe out any benefit I there was from this account.

That's a risk you'd have to take. But it would take a pretty hefty interest rate rise to make the 8% account worse than paying off the mortgage. It would certainly reduce the benefits, though, making it a less good use of your time sorting it out.