Overpay Mortgage or Keep Gaining Interest

chrisrsmith

Hi

I am no accountant ……

I am paying 2.59% mortgage on approx 120K, 6 years to go
I am gaining 3% on savings TAX FREE
I can overpay mortgage pre July 2104 £10K

Q - should I overpay mortgage or keep gaining the 3% interest?

BR
Chris

adindas

chrisrsmith wrote: »

Hi

I am no accountant ……

I am paying 2.59% mortgage on approx 120K, 6 years to go
I am gaining 3% on savings TAX FREE
I can overpay mortgage pre July 2104 £10K

Q - should I overpay mortgage or keep gaining the 3% interest?

BR
Chris

Saving Interest rate 3% (net), Martgage Interest 2.59%.
Margin, 0.41%

Obviously, no need to overpay at the moment ...

atush

Why are you saving in cash only?

ironlady2022

I don't have a mortgage but should you be comparing the interest gain on the 3% depending on the amount you have in there? And compare this to the amount you would save on interest on your mortgage amount? The mortgage interest is it calculated on the whole amount per annum? In which case unless you have a lot of savings paying off the mortgage may be the better option.

jimjames

chrisrsmith wrote: »

Hi

I can overpay mortgage pre July 2104 £10K

s

That is an awfully long mortgage term!

chrisrsmith

mayling03 wrote: »

I don't have a mortgage but should you be comparing the interest gain on the 3% depending on the amount you have in there? And compare this to the amount you would save on interest on your mortgage amount? The mortgage interest is it calculated on the whole amount per annum? In which case unless you have a lot of savings paying off the mortgage may be the better option.

That's where I am seeking advice - and indeed the amount gaining 3% is important (my bad for not mentioning) is 90K. So yes considering just a year it's simple - but over the term of the mortgage, what is the better thing to do?

chrisrsmith

atush wrote: »

Why are you saving in cash only?

I also have a cash ISA

uknick

Ask your mortgage lender how much your monthly "interest" payments are. Then, ask how much your monthly payments will be if you make an overpayment.

Work out how much you will save over the remaining life of your mortgage compared to what you get in interest.

Should make the answer a lot clearer as you should then be comparing apples with apples.

bowlhead99

uknick wrote: »

Ask your mortgage lender how much your monthly "interest" payments are. Then, ask how much your monthly payments will be if you make an overpayment.

Work out how much you will save over the remaining life of your mortgage compared to what you get in interest.

Of course, it's worth pointing out that if the 2.59% is not fixed for the whole life of the mortgage product, or if any expiring savings income products aren't guaranteed to be renewable at 3% for the next 6 years, it isn't quite as simple as that.

For example with the lost interest income offset by reduced mortgage payments, the net saving over the next year, by having used up your cash to make a 10k overpayment is about 40-odd quid (~0.4%). Assuming you don't have any interest penalties for withdrawing the savings from the accounts they're sitting in, to make the overpayments.You have probably done this calculation already. This would compound over the life of the mortgage and may be worth having, as in total it potentially will save you 200-300 quid over the years. You may value that net money saved more than you value the flexibility of having 10k extra in your cash pile; no doubt there are others who would think the opposite.

If your mortgage rate is variable then it will potentially rise at some point, and if you didn't take advantage of the opportunity to make this year's 10k overpayment, you may have missed the boat because you are capped on what you can overpay without penalties next year. So that would maybe nudge you towards paying it off.

Another thing that would nudge you that way, is that getting 3% interest tax free on 90k is quite hard to do at the moment. So if you're currently on a fixed deposit term which expires any time soon, you may find you can't renew it at 3% and your average rate falls to 2% or less, meaning the net annual saving from overpaying gets bigger. This makes paying off the mortgage more compelling, *if* you know there will be no event in your life that might need the 10k of cash in the next 6 years.

The final reason to overpay is if the 10k gets you materially closer to a better Loan-To-Value ratio at which you can remortgage to a better rate, knocking down your interest cost not just on the 10k paid off but also the 110k remaining balance. Say you were paying 2.59% because your mortgage is 75% of your property value; can you get the mortgage down to 69.99% L-T-V and reduce the rate further?

However, if the mortgage rate is fixed for the 6 years and you're nowhere near a useful LTV threshold, it is less of a no-brainer, as savings rates may improve over time and the 40 quid annual gain from overpaying could be a 40+ quid annual loss in say 3 or 4 years time.

chrisrsmith wrote: »

atush wrote: »

Why are you saving in cash only?

I also have a cash ISA

That seems a strange answer as a cash isa is a simply a cash 'individual savings account'. So if you have cash in a current account or savings account and cash in an ISA, you're still all in cash.

Atush was alluding to other options which may provide better income and/or growth, such as investment funds. Obviously these come with risk involved but could work for a portion of your 90k cash pile. The option of 'what to do with 10k' is not just make a 10k overpayment or put it in a savings account. Some people would invest it hoping to beat your 2.59% return averaged over a 6 year period. A typical investment in an average equities fund would have returned five or ten times that rate in the last year, though obviously may produce losses in other years.

I also have a cash ISA

By 'also' an ISA you mean as part of the 90k of tax free cash savings? To be honest, I'd presumed the 90k was all in cash ISAs as that's the most common way people save tax free.

Are you just saying your savings are all tax free because you're not a taxpayer anyway? Or are they in some other tax-free scheme like national savings index linked certificates which have a variable rate and a fixed term of less than the 6 years on your mortgage?

Anyway, hope the above gives you some thoughts. The decision will be different for everybody. Personally if I had a 2.59% mortgage I wouldn't hurry to pay it off unless it was a variable rate and I expected it to rise sometime soon.

chrisrsmith

bowlhead99 wrote: »

Of course, it's worth pointing out that if the 2.59% is not fixed for the whole life of the mortgage product, or if any expiring savings income products aren't guaranteed to be renewable at 3% for the next 6 years, it isn't quite as simple as that.

For example with the lost interest income offset by reduced mortgage payments, the net saving over the next year, by having used up your cash to make a 10k overpayment is about 40-odd quid (~0.4%). Assuming you don't have any interest penalties for withdrawing the savings from the accounts they're sitting in, to make the overpayments.You have probably done this calculation already. This would compound over the life of the mortgage and may be worth having, as in total it potentially will save you 200-300 quid over the years. You may value that net money saved more than you value the flexibility of having 10k extra in your cash pile; no doubt there are others who would think the opposite.

If your mortgage rate is variable then it will potentially rise at some point, and if you didn't take advantage of the opportunity to make this year's 10k overpayment, you may have missed the boat because you are capped on what you can overpay without penalties next year. So that would maybe nudge you towards paying it off.

Another thing that would nudge you that way, is that getting 3% interest tax free on 90k is quite hard to do at the moment. So if you're currently on a fixed deposit term which expires any time soon, you may find you can't renew it at 3% and your average rate falls to 2% or less, meaning the net annual saving from overpaying gets bigger. This makes paying off the mortgage more compelling, *if* you know there will be no event in your life that might need the 10k of cash in the next 6 years.

The final reason to overpay is if the 10k gets you materially closer to a better Loan-To-Value ratio at which you can remortgage to a better rate, knocking down your interest cost not just on the 10k paid off but also the 110k remaining balance. Say you were paying 2.59% because your mortgage is 75% of your property value; can you get the mortgage down to 69.99% L-T-V and reduce the rate further?

However, if the mortgage rate is fixed for the 6 years and you're nowhere near a useful LTV threshold, it is less of a no-brainer, as savings rates may improve over time and the 40 quid annual gain from overpaying could be a 40+ quid annual loss in say 3 or 4 years time.

That seems a strange answer as a cash isa is a simply a cash 'individual savings account'. So if you have cash in a current account or savings account and cash in an ISA, you're still all in cash.

Atush was alluding to other options which may provide better income and/or growth, such as investment funds. Obviously these come with risk involved but could work for a portion of your 90k cash pile. The option of 'what to do with 10k' is not just make a 10k overpayment or put it in a savings account. Some people would invest it hoping to beat your 2.59% return averaged over a 6 year period. A typical investment in an average equities fund would have returned five or ten times that rate in the last year, though obviously may produce losses in other years.
By 'also' an ISA you mean as part of the 90k of tax free cash savings? To be honest, I'd presumed the 90k was all in cash ISAs as that's the most common way people save tax free.

Are you just saying your savings are all tax free because you're not a taxpayer anyway? Or are they in some other tax-free scheme like national savings index linked certificates which have a variable rate and a fixed term of less than the 6 years on your mortgage?

Anyway, hope the above gives you some thoughts. The decision will be different for everybody. Personally if I had a 2.59% mortgage I wouldn't hurry to pay it off unless it was a variable rate and I expected it to rise sometime soon.

Hi Bowlhead 99,

Thank you for your response, it was very useful and of great assistance.

Concerning a couple of aspects that I had not made clear in my original entry…

I have two cash ISA's in addition to the 90K.
My LTV is 25%
I am a non-tax payer
The mortgage deal is currently fixed at the current rate until July 2015. I can 'overpay' 10% each year.

I am of course very interested if any of this additional data changes your opinions at all.

BR
Chris

bowlhead99

chrisrsmith wrote: »

Hi Bowlhead 99,
I have two cash ISA's in addition to the 90K.
My LTV is 25%
I am a non-tax payer
The mortgage deal is currently fixed at the current rate until July 2015. I can 'overpay' 10% each year.

I am of course very interested if any of this additional data changes your opinions at all.

A few points based on this new info:

- Making an overpayment on a mortgage to duck into another LTV threshold and save interest on the whole mortgage, is not available to you. So one reason for paying off the mortgage has disappeared with the information that you're already down to 25%.

- Then, the mortgage rate is only fixed for one year after your Jul 2014 'deadline' to make an overpayment of 10k. There are a couple of aspects to this:

• for a person with a long mortgage fix or locked into a tracker and a cap on overpayments, the benefit from overpaying in every year is that with respect to the overpayment option, they have to 'use it or lose it'; if they don't overpay 10k this year or next they can't suddenly decide to overpay 30k the year after. This means it's quite a serious choice whether to overpay or not if they were otherwise sitting on the fence. Paying or not paying, for someone like that, is quite inflexible because if they overpay they can't easily take the cash back out and if they don't overpay, they can't pay a big lump later if their needs change or the alternative uses for their cash become less attractive.

However, for you, with only one year to go after your July decision-making deadline, it is not too much of an issue. You will get the chance to make unlimited overpayments penalty free, or remortgage entirely, once you drop off your fix. So that's less incentive to overpay now.

• Also, given the likely direction of mortgage rates in a couple of years time is upwards (given rates are currently all-time lows and the expected removal of 'Help to Buy', funding for lending etc etc) - you should probably assume the last 4 years of the mortgage are at a higher rate than 2.59%.

However, this is a red herring because you can presumably use your spare cash to overpay then if you want to (i.e. when you drop off your fix) based on the rates prevailing for mortgages and savings and investments. So you don't need to do a calculation compounding all the way out for the rest of the life of your mortgage because your interest rates are not fixed for the life of your mortgage and any choice not to overpay in the first half of 2014 can easily be reversed 18 months from now - when you can pay off an extra 10k or 50k or 90k if that suits you based on your personal finances and the market at that point.

- based on other information you've posted here this summer, you are 51/52ish , right? And redundant from a previous job and worked overseas on a temporary contract during the current year. But now I presume that has finished as you say you are a non taxpayer. So without knowing the intimate details of your life there are a few obvious points to make if you're considering maxing your mortgage overpayments.

1) if you get another job you will surely earn more than the minimum wage required to pay income tax. Whether you end up resident in UK and paying tax to HMRC on your worldwide savings and investment income, or you end up resident in Germany and paying tax to the Germans on your worldwide savings and investment income, there doesn't seem to be any way of getting interest income on the 90k of cash that is outside ISAs without paying tax on it. Feel free to correct me if I'm wrong.

So you shouldn't be looking at tax free interest income as your comparison with mortgage interest saved - consider your marginal rate. As well as the sustainability of that 3% gross rate if you are not using stocks/shares investment funds.

2) If you don't get another job ; some of my comments above presumed that you would be easily able to remortgage onto another fixed or tracker product in summer 2015; however if your employment history leading up to it is patchy you might struggle to get the absolute best rate (even with your low LTV) if you are declaring that you don't get enough income to even be paying tax on savings income. If you are stuck on a lenders SVR which is considerably higher than the market leading rates, it would be better to have a smaller mortgage than persist in trying to cover it out of net interest income. Of course if you are on SVR you can overpay whatever you like so perhaps the point is moot.

More generally if you find jobs are not easy to come by as you get older and/or you want to do something financial for your kids, you might value the big 'emergency / investment fund' more than you value saving the odd few pounds of interest expense, as long as you have a plan to clear the mortgage eventually.

HTH