'Don't shorten your mortgage term if you can overpay' blog discussion

SuperSecretSquirrel

There is one situation where formally reducing the mortgage term makes sense.

Say you (like me) have a mortgage that limits annual overpayments to 10% of last years end balance, but you can comfortably afford to overpay more than this. If you reduce the term, this increases your minimum monthly payment, something the blog article considers a bad thing. I understand that it increases your risk to some degree, which may be undesirable for some, but it also means that you'll be making larger monthly payments and can still overpay that 10% of last years end balance on top. The more you can pay off quickly the better - paying off more each year saves you money in the long term (provided life goes reasonably smoothly). Reducing the term and also overpaying as much as possible would be optimal. I freely admit it took a while for this to sink in for me, I had it spelled out to me by a very helpful mse forum member on my mfw diary!

I personally overpaid without reducing term to start, then when it became obvious we could pay off more than the 10% allowance in a year we calculated what monthly minimum payment we were comfortable committing to and formally reduced the term to match. We still have some financial slack, and I can overpay the full 10% allowable on top of the increased monthly minimum payments. We will be mortgage free much quicker than had we not reduced the term, and will save thousands of pounds too

JimmyTheWig

SuperSecretSquirrel wrote: »

There is one situation where formally reducing the mortgage term makes sense.

Say you (like me) have a mortgage that limits annual overpayments to 10% of last years end balance, but you can comfortably afford to overpay more than this. If you reduce the term, this increases your minimum monthly payment, something the blog article considers a bad thing.

To be fair, the article says "Don't shorten your mortgage term if you can overpay". In your case I would argue you fit more into the category of those who can't overpay - i.e. the limits on your overpayment are restrictive for you.

In our case we have the same 10% restriction as you but (almost) never come close to them. So for us, we can always overpay. For you, you can't.

Increasing your monthly commitment is a bad thing.
Paying more off your mortgage is a good thing.
If you need to do the bad thing to be able to do the good thing then you have to balance the merits of the two (which, in your case sounds like reducing the term is worthwhile) but if you don't need to then don't.

hugonellie

I am absolutely confused by this - sorry I'm blonde!

I'm with nationwide and my monthly mortgage payment was £515 on a 68k debt (i think its 4.19%) fixed for another 3 years.

however I spoke to nationwide and now have a fixed monthly payment of £600 a month - which I can easily afford, and have paid now for some time. Occasionally I pay another £100 here and there on top of that again. So a monthly regular overpayment of £85 - which has built up a decent fund - which I can see when I login to my online mortgage statement. I took out a 5 year fix, with a full term of 15 years originally

I have no idea if I am reducing the term, or reducing the monthly payment - should I be finding this out - or am I doing the right thing?

edit: I have just logged in and it says this....

If you overpay by less than £500, the balance of your mortgage will reduce and you will be charged interest on the lower balance from the following day. At the next natural mortgage payment change, your monthly payment will be recalculated to include any overpayments you have made.

If you overpay by £500 or more, you can choose how this affects your mortgage. Just select an overpayment option from the list on the right and 'confirm'.

am I better off saving up my overpayments in a savings account and making greater £500+payments less regularly?

byebyedebt

Provided your interest is calculated daily, you are saving money.

Waboc

I'd appreciate some thoughts on my situation if you could please.

I'm with Nationwide and like a lot of people can overpay 10% per year. I'm in the pposition where I have that 10 percent sat in an ISA earning next to no interest and seems sensible to get the mortgage paid off with it as a lump sum, given its money I don't touch. That's minor question A, pretty sure the logic is sound!

My main question is reducing the term versus reducing monthly repayments, bearing in mind that I plan on selling the house before the mortgage term is finished. To my eye reducing the term is only worthwhile if you see out the full term? Otherwise you don't have the overpayment money to spend or gain interest on any more, and your monthly repayments stay the same so where's the benefit short term? Overpaying the lump sum would reduce my monthly rrepayments by £35, or £420 annually, whereas the ISA only gets around £100 interest so i'd be putting that money to better use, no? Immediately get the benefit. And then when selling you've already had the benefit.

Or have I totally misunderstood the significance (or lack of) of selling the house before you've paid the full mortgage off?

SuperSecretSquirrel

If your mortgage charges a higher percentage than your ISA earns, withdrawing ISA funds to pay a mortgage lump sum would be sensible, but keep in mind that you'll never get the tax shelter back for past years.

Regardless of whether you reduce the term or reduce the monthly minimum payment, what you are really doing when overpaying the mortgage is reducing the outstanding capital debt. Chipping away at the capital at an accelerated rate saves a lot of compound interest. If you overpay and take the reduced monthly payments option and spend (or save in a poorly performing savings account) the difference, it's pretty much a zero sum game. The key is to overpay, and when your monthly minimum payment reduces maintain the old payment amount (in effect overpaying every month from then on). So if your mortgage is currently £500 a month, if you pay in your ISA lump sum and the minimum monthly payments drop to $465, keep on paying the £500 to benefit from an "automatic" monthly overpayment. If you can overpay more, even better.

Overpaying the mortgage and short term benefit don't really go hand in hand, but the medium/long term benefits are immense. It's pretty much a case of delayed gratification. When you sell the house has no real bearing on the math, when you come to sell having overpaid the mortgage, your outstanding loan will be lower, and that's usually a good thing.

JimmyTheWig

hugonellie wrote: »

I'm with nationwide and my monthly mortgage payment was £515 on a 68k debt (i think its 4.19%) fixed for another 3 years.

however I spoke to nationwide and now have a fixed monthly payment of £600 a month - which I can easily afford, and have paid now for some time.

Is this something that you have committed to?
Unlikely, I know, as you've said you can easily afford it but if your circumstances changed and you spoke to them and asked to go back to the £515 a month would they let you automatically?
I think, from what you've said, that yes they would. In which case this is perfect.

If you overpay by less than £500, the balance of your mortgage will reduce and you will be charged interest on the lower balance from the following day. At the next natural mortgage payment change, your monthly payment will be recalculated to include any overpayments you have made.

This is exactly what Martin is saying that you should do in his blog. Your monthly minimum commitments will go down which is perfect to allow room for future changes of circumstances.
You may want to, at that time, increase your overpayments to keep your monthly payment at £600.

If you overpay by £500 or more, you can choose how this affects your mortgage. Just select an overpayment option from the list on the right and 'confirm'.

am I better off saving up my overpayments in a savings account and making greater £500+payments less regularly?

The impact of this would be to increase your monthly minimum commitment.
As you don't appear to be restricted (in reality) by how much you can overpay by then there is no need to increase this.

So I would say, and Martin's blog would agree with this, that you're doing the right thing now.

hugonellie

JimmyTheWig wrote: »

Is this something that you have committed to?
Unlikely, I know, as you've said you can easily afford it but if your circumstances changed and you spoke to them and asked to go back to the £515 a month would they let you automatically?
I think, from what you've said, that yes they would. In which case this is perfect.


This is exactly what Martin is saying that you should do in his blog. Your monthly minimum commitments will go down which is perfect to allow room for future changes of circumstances.
You may want to, at that time, increase your overpayments to keep your monthly payment at £600.


The impact of this would be to increase your monthly minimum commitment.
As you don't appear to be restricted (in reality) by how much you can overpay by then there is no need to increase this.

So I would say, and Martin's blog would agree with this, that you're doing the right thing now.

Ahhhh thank you, its reassuring to know I'm doing something right! :beer:

If I really needed to drop my monthly payments back down I certainly could, my fixed payment is £515 - for ease I just changed the direct debit to £600 so I didn't have to manually keep making the overpayments through my online banking - I've now just come to terms that that is my mortgage payment - mentally its better for me this way as I've never missed a month

jamesd

To continue with Martin's shorter term example "shortening the term increases the monthly cost, but cuts the total interest by £18,000 – a monumental saving"

Now put the money into a UK stock market tracker fund instead. A regular savings calculator shows that the same higher monthly payment of £161 for 20 years at the lower end of the long term UK stock market performance*, about 8%, would produce a pot of £94,832.

I'm not sure what to call that since Martin already called only £18,000 monumental. Perhaps gargantuan?

Naturally you don't have to continue for the full twenty years. You could just pay off the mortgage once the total reached a level high enough to do that.

Of course that result is not guaranteed, it's investing. But there's very little chance of it being less good than overpaying on the mortgage, which would take some pretty stupendously bad investing times. Perhaps a replay of the great Depression starting just when you [STRIKE]start[/STRIKE] end the twenty years.

Overpaying wins for those who just can't deal with investing, though, and in that case it's one of the better options around. It's also the way to go for those who just want to see the mortgage being paid off with extra regular bits.

*long term is about 5% plus inflation, about 8-9% at the moment. I used 8% to allow for charges and err on the low side a bit.

JimmyTheWig

jamesd wrote: »

Of course that result is not guaranteed, it's investing. But there's very little chance of it being less good than overpaying on the mortgage, which would take some pretty stupendously bad investing times. Perhaps a replay of the great Depression starting just when you start the twenty years.

A Great Depression at the start of the 20 years would be fine. It's a Great Depression at the end of the 20 years that would hurt.