Overpayment or Savings?

boybeck

I've been reading these forums for a while and I just want to confirm what I'm doing is correct.

My Nationwide mortage (27k) is fixed at 5.48%

My Egg ISA rate is 6.05%

So, instead of making overpayments I am putting the money into my ISA because the interest rate is higher.

Am I right in thinking this will be generating me more money than the amount it would save if the money was reducing the mortgage?

Jonmurgie

This is something that we'd also like to just have confirmation on... so just going to jump in with a similar question if I may!!

We've just started a 2 year fixed rate @ 5.14% with Halifax (balance of £171k for 20 years... eek!).

Reading through on the forum we decided it was best to put any overpayments into ISA's with a goal of getting 2 ISA's (one each) full to 3k by the end of the tax year, and have opened up Egg ISA's @ 6.05%

As boybeck has asked, is this the best way of going as the interest rate on the ISA's is higher that the Mortgage?

Appreciate any thoughts on this that we're going the right way about it as we're quiet flexible to do something better if needs be!

Kind regards
Jon

ThankYouAndEnjoy!

Hello Jonmurgie & boybeck

Both of you are correct in the action you are taking. Basically, you utilise all available savings products that give you a higher Gross APR (ISA Tax Free) than that of your mortgage. These will yield better returns than making o/payments on your mortgage.

You will however need to factor in any personal circumstances (why do you want to make o/payments etc) as well as any restrictions on o/payments both when you can o/pay and how much you can o/pay.

Jonmurgie

Thanks for the confirmation ThankYouAndEnjoy... I know with our mortgage we can overpay by 10% per year whenever or however we like, though as it's only for 2 years we'll probably just keep an eye on the ISA rates etc. and pay a chunk off when we re-mortgage in 2 years time.

Goal is to get it all gone in around 9 years... we shall see I guess!!

ailuro2

ailuro2 wrote: »

I have a theory that paying off your mortgage earns more interest than just the interest rate you pay on your mortgage.

If I were to pay off £100 a month for 5 years on a 20 year mortgage at a rate of 5.5% it would save me £7519 by doing so.

If I were to save £100 pounds a month for 5 years at 5.5% then end of 5 years it is worth £7056.

I reckon this is because at the start of a mortgage we pay interest on the total outstanding, plus an amount towards the capital repayment. As the years go on,we pay less interest and a greater capital amount thereby paying off the remainder of the original loan-by keeping the mortgage payments the same the ratio changes. Hope this makes sense.

Now, by repaying some of your capital sooner, it frees up some of your monthly payment that would have gone on paying interest to be paid to your capital repayment, hence the difference in figures above.

Try it out for yourself- here are two links-

http://www.thisismoney.co.uk/calculatorsthen click on long term savings calculator for how much the savings are worth after 5 years.

and http://www.co-operativebank.co.uk/servlet/Satellite?c=Page&cid=1076576252005&pagename=CoopBank%2FPage%2FtplPageStandard has a calculator link near the bottom of the page that lets you put in overpayments and on the right hand side of the calculator it tells you how much interest you saved.

I have to have an interest rate of 7.62% to equal the amount of interest saved by overpaying on the mortgage- a full 2.12 more than the interest on the mortgage.

I am repeating myself here, but can anyone shed any real light on whether I'm right or wrong?

ThankYouAndEnjoy!

Hello Ailuro2

The example given, and the calculator used, take off Tax from the amount invested (savings). this is why the amounts differ. As long as the OP and Poster 2 make sure they save at above the APR Gross, then they are better saving than o/paying.

The example given, 5.5% for both mortgage + savings gives zero difference either way

Jonmurgie

I guess that's why the question pops up as it's not that clear when you use the calculators are face value...

As mentioned, I'm personally aware that its important to keep an eye on the actual interest rate on the savings and any tax implications. For us we've only just started out on the savings and currently will be using ISA's which are tax free so at the moment we're OK with Egg's 6.05% but that is variable so will be keeping an eye on it!

ailuro2

Since I can't find a calculator that tells me it is without tax I worked it out myself using Excel- adding £100 a month and adding daily interest of 5.5%/365 and compounding it, it still works out at less than can be saved on mortgage payments.

Please, go ahead and do it yourself, if you're as picky as me- I'd love someone to tell me I'm not talking nonsense- like I said my theory is the capital that has been repaid early incurs no interest,which means more of your standard mortgage payment goes towards paying the capital off instead of paying for interest.:D

5.5% £6921.938746
6.0% £6924.30948
6.5% £7108.974949
7.0% £7204.93823
8.0% £7401.91414
8.5% £7502.99234

ps Here are my figures for comparison, and the interest rates used, no tax taken off.

Snow_Dog

You know, i'd never thought of that one before, but it is obvious when you think about it.

Because you have made an overpayment of £100 but not dropped the regular mortgage payment, your regular payment is now working harder for you because it is paying off fractionally more each month from that point on.

Is it not cancelled out though by the savings earning interest on the interest accrued in subsequent years?

Oh !!!!!!, this now means several hours proving it beyond doubt in Excel.

RainbowsInTheSpray

So it's a simple rule?

If your mortgage rate is lower than what you can find on offer in savings accounts (irrespective of what the latter call themselves), you would be shooting yourself in the foot by making 'overpayments'..?

Ok, then can anyone point me at where I should bury my pennies after I've used up my annual ISA allowance..?

InMyDreams

ailuro2 wrote: »

Since I can't find a calculator that tells me it is without tax

Try this one. http://www.fool.co.uk/savings/savings-calculator.aspx

ailuro2 wrote: »

I worked it out myself using Excel- adding £100 a month and adding daily interest of 5.5%/365 and compounding it

Compounding daily or monthly? Compounding daily, this method would give you an apr of about 5.65%. Monthly, something a bit less (but more than 5.5%)

ailuro2 wrote: »

Please, go ahead and do it yourself

OK, my results are...

5.5% £6895.201
6.0% £6982.401
6.5% £7070.611
7.0% £7159.841
8.0% £7341.398
8.5% £7433.744

ailuro2 wrote: »

I'd love someone to tell me I'm not talking nonsense

Erm... maybe you are just a bit confused. ;-)

ailuro2 wrote: »

- like I said my theory is the capital that has been repaid early incurs no interest,which means more of your standard mortgage payment goes towards paying the capital off instead of paying for interest.:D

But the same could be argued for the savings. What do you do after the five years is up? Do you empty the savings account and put the money under the mattress until the mortgage is finished? No. You either use the savings (plus accrued interest) to pay off a chunk of the mortgage (so your capital will still be repaid early) or you keep it in a high interest account to earn even more interest.