Overpayment or Savings?

InMyDreams

RainbowsInTheSpray wrote: »

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'..?

Mathematically, yes. But there is more to it in practice.

Don't make a mistake by forgetting about the tax or getting complacent with checking that your interest rates remain competitive.

Also, by paying directly off the mortgage you can immediately see the years being shaved off which can act as a motivator.

You have to be extremely disciplined. You must treat those savings as if they have already paid off the mortgage. If you were to dip into them, it would be equivalent to remortgaging again. Would you remortgage your house for that car/holiday/new kitchen? If the answer is yes, then dip away, but be aware of what you are doing. Can you resist the temptation?

There is also then the temptation to take it one step further and go interest only and completely manage your own capital 'repayments' into a savings account or other investment. But then mistakes can be even more costly if a miscalculation means you haven't got the money to pay off the mortgage at the end of the term.

RainbowsInTheSpray wrote: »

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

You could start with some regular savers... they offer the best guaranteed rates of return. How risk-averse are you? Savings and investments board is probably a better place to be asking.

CharleneUK

Hi OP, this is exactly what hubby and I are doing! In fact, I just opened my egg ISA last night!

Best of luck to you.

ailuro2

I was adding the interest daily-

for example,in Excel cellB5 equalsB4*$C$2 where C2 is interest rate divided by 365, plus 1 (which makes a figure of 1.0001506849 for 5.5% interest)
Pull the formula down to 5 years worth of the cells below(column A was for dates)

This adds the daily interest on,then each month do +£100,continue until you get to the bottom of 5 years.

So, while I'm a tad off with the interest rates,there IS something in my theory about my regular mortgage payment now working harder? :j

Fantastic, I though I was going a bit mad,:o although hubby grasps the idea too.



Quoting In My DreamsBut 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.
Well the comparison is for five years because you need to pick a date to compare the amounts of money.

The amount you have saved over five years paying into your mortgage is WORTH MORE than 5 years saving plus interest, that is the point I am making. Overpaying by £100 at an interest rate of 5.5% will save you around 7500 over a 5 yr period. To earn the same doing monthly equivalent savings you need to earn at least 8.5% nett. So never mind the possibility of dipping into the savings fund- you need to find savings at a 3% higher rate to break even.

fwiw We can access our overpayment anytime- most allow you to do this,but not all.:D

Snow Dog- PM me if you want to save a bit of time in Excel- I already sat and did it in Excel and am happy to send it to you

Kaz2904

Another thing that people are forgetting is that if you have overpaid your mortgage and lose your job then your overpayments will not affect any benefits but savings will. You cant turn round and chuck 30k worth of savings onto the mortgage before you apply for benefits either because you would get caught!

mojo_jojo

In the end, a few hundred pounds difference at the end of 5 years in overpayments or in savings is not that much. There's the psychological aspect as well. It's better to see your large mortgage reducing quicker every month rather than money slowing building up in your savings. Also there is the temptation to spend savings, but your unlikely to take payment holidays once money has gone into a mortgage.

Thinks about it, you can have paid £12k in overpayments into your mortgage, or you can have £12k sitting in an account and it's saying "spend me!".

CharleneUK

I agree to some extent mojo jojo, but then again, it's all about self discipline. I know for a fact that unless hubby or I lost our jobs, we would not touch the money.

Jonmurgie

I got to say that I thought it was much more clear-cut than it seems... basing it on the fact that if you can get a better rate (after any possible tax) I thought it was best to SAVE the money, yet I can see the point (and the psychological point) of paying it off the mortgage and seeing the capital decreasing... hmmm... now I'm more confused than ever, think I'll post up a thread with our specific scenario as I've just convinced the OH to give paying our 20 year mortgage off in just under 9 (i.e. by my 40th)

bunking_off

ailuro2 wrote: »

The amount you have saved over five years paying into your mortgage is WORTH MORE than 5 years saving plus interest, that is the point I am making. Overpaying by £100 at an interest rate of 5.5% will save you around 7500 over a 5 yr period. To earn the same doing monthly equivalent savings you need to earn at least 8.5% nett. So never mind the possibility of dipping into the savings fund- you need to find savings at a 3% higher rate to break even.

I think you're going wrong with your calculation somewhere or not comparing like with like. So long as both interest rates are stated on the same basis, then putting your money in an after-tax savings account with interest rate of 5.5% will have exactly the same effect as overpaying the same amount off a mortgage at 5.5%. Overpayment makes sense (particularly for higher rate taxpayers) because other than ISAs, finding a risk free savings account that pays the same as typical mortgage rates net of tax is pretty difficult. For the record, on your example I make the saving approx £6800 either way (£6875 but I simplified by making an overpayment of £3.29/day rather than £100 lump sum/month).

Having had a play, I think something must have gone wrong when you plugged the figures into the Co-op calculator. As a comparison, I took a £100k mortgage over 20 years at 5.5%...this gave a monthly payment of £684.85 and in July 2012 the outstanding balance would be £84,188. Now, if I then applied a £100 overpayment for the first 5 years, the amount outstanding in July 2012 would be £77,300. Therefore, by doing the overpayment you're better off by £6888 (£84188 minus £77300)...recognise the figure from above? I don't know how you got £7500, unless you took the "interest saved" figure from their site. However, that wouldn't be comparing like with like because for comparison even if you didn't put any more money in the savings account after the 5th year, it would accrue interest.

There is a complication that mortgage interest rates are never so simple. For example interest may be calculate daily but only applied monthly. Or, like on my mortgage be downright misleading (they apply {rate/365} daily, which actually gives a rate for comparison with savings accounts of 1+{rate/365}^365-1....in your 5.5% example this works out to 5.65%).

InMyDreams

ailuro2 wrote: »

I was adding the interest daily-

for example,in Excel cellB5 equalsB4*$C$2 where C2 is interest rate divided by 365, plus 1 (which makes a figure of 1.0001506849 for 5.5% interest)
Pull the formula down to 5 years worth of the cells below(column A was for dates)

This adds the daily interest on,then each month do +£100,continue until you get to the bottom of 5 years.

Oh, OK, so you are actually calculating and adding on and therefore compounding the interest daily. I don't know of any savings accounts that do that, so it would be difficult to compare interest rates like this. Most (if not all?) will calculate the interest daily but only add it on to the account monthly or annually. You don't start earning interest on the interest until it is added to the account. That's why all savings accounts have to publish a notional apr figure so that you can compare them, even though that's not the figure used to calculate the interest.

ailuro2 wrote: »

So, while I'm a tad off with the interest rates,there IS something in my theory about my regular mortgage payment now working harder? :j

I still don't think so. I think you are over estimating how much you are saving by overpaying your mortgage.

ailuro2 wrote: »

Well the comparison is for five years because you need to pick a date to compare the amounts of money.

The amount you have saved over five years paying into your mortgage is WORTH MORE than 5 years saving plus interest, that is the point I am making. Overpaying by £100 at an interest rate of 5.5% will save you around 7500 over a 5 yr period.

How did you work this out? I can't get the calculator you linked to to work on my computer, but this seems very high.

InMyDreams

Crossed in the post ;-) (I got distracted mid post...)

bunking_off wrote: »

There is a complication that mortgage interest rates are never so simple. For example interest may be calculate daily but only applied monthly. Or, like on my mortgage be downright misleading (they apply {rate/365} daily, which actually gives a rate for comparison with savings accounts of 1+{rate/365}^365-1....in your 5.5% example this works out to 5.65%).

yes, that's where I got distracted ;-)

Which savings rate should we be using to compare? the notional apr or the actual rate used for calculating the figures (which is a bit lower if interest is added monthly to allow for the compounding effect). There is no such thing as an apr for mortgage rates. Presumiably the headline rate is more comparable to a gross savings interest rate that's applied monthly, and we'd have to work out a notional rate to compare savings account that add annually.

Must drag myself away from the computer and get on with some 'real' work...