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

Horizon81

JimmyTheWig wrote: »

Yes you are saving money doing it this way.
You are also keeping your minimum repayment low (which is a good thing, as per Martin's blog entry, if circumstances change in the future).
And if I understand correctly that the monthly overpayments you make are automatically taken from your bank, you are _also_ ensuring you don't choose to not overpay some months with no valid reason.

This set up sounds perfect!

Forgive my stupidity but can you explain how this is saving money? If the bank reduces the monthly payment, but keeps the term the same, but you increase the voluntary excess amount to the same total, how does this save money, i.e. reduce the interest paid?

jamesd

JimmyTheWig wrote: »

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.

Yes, it is, thanks for the correction.

[STRIKE]Not so. For retirement the biggest risk is a big drop in the early years then low growth for a long time. That means that the effect of capital withdrawing is relatively large and long-lasting. By the end there should be plenty of safety margin still remaining and less capital drawing time to be harmed by the sustained drop.

If you look at the blog entries on sequence risk by Wade Pfau they cover this topic.

One effective method to reduce the risk of a big early drop is having a year's drawings in cash, so you can do things like not drawing on capital during downturns. But this won't help so much with the long drawn out case, just the more usual ones.[/STRIKE]

JimmyTheWig

Horizon81 wrote: »

Forgive my stupidity but can you explain how this is saving money? If the bank reduces the monthly payment, but keeps the term the same, but you increase the voluntary excess amount to the same total, how does this save money, i.e. reduce the interest paid?

Not totally sure what you're asking but I'll try to answer.
You're saving money on interest by keeping your balance lower than it would be if you didn't do this.
Even though the term stays the same, you will pay off your mortgage early. If you kept up this method continuously then you'd get to the point where your monthly repayments were tiny and your voluntary overpayments were huge in comparison. Then one month you would make your overpayment and it would clear the mortgage. The number of months left of the term, multiplied by your regular monthly payment, will be the amount you have saved in interest.


But if you are asking how does this save money over reducing the term officially then the answer is it doesn't. It is the same, money-wise. But it does give you a safety net, which is what the blog is talking about, without costing you any extra.

JimmyTheWig

jamesd wrote: »

Not so. For retirement the biggest risk is a big drop in the early years then low growth for a long time. That means that the effect of capital withdrawing is relatively large and long-lasting. By the end there should be plenty of safety margin still remaining and less capital drawing time to be harmed by the sustained drop.

But we're not talking about withdrawing money from a pot for retirement (in which case yes I agree a hit at the beginning would be bad). We're talking about building up a pot to pay off a mortgage.


Lets say you pay in £1000 a year.


Scenario 1: A 50% drop at the end of the first year followed by 19 years of 0% increase.
Balance after 1 year: £500.
Balance after 20 years: £19,500.


Scenario 2: 19 years of 0% increase followed by a 50% drop at the end of the 20th year.
Balance after 19 years: £19,000.
Balance after 20 years: £10,000.

jamesd

Sorry, you are right. In this case it is a drop at the end that hurts most.

One of the easiest ways to protect against that is to start making payments from the invested money before the end date. Since investing will typically produce enough to pay off the mortgage well before the end date there's plenty of time to do this. You might do something like using 10% of the pot for payoff for each of the final five years of the plan, say, skipping that if the market drops a lot during one of the years until after it has recovered.

missprice

jamesd wrote: »

Sorry, you are right. In this case it is a drop at the end that hurts most.

One of the easiest ways to protect against that is to start making payments from the invested money before the end date. Since investing will typically produce enough to pay off the mortgage well before the end date there's plenty of time to do this. You might do something like using 10% of the pot for payoff for each of the final five years of the plan, say, skipping that if the market drops a lot during one of the years until after it has recovered.

Or you could just overpay the mortgage and not faff about.

Keeping it simple is usually better.

JimmyTheWig

missprice wrote: »

Or you could just overpay the mortgage and not faff about.

Keeping it simple is usually better.

It depends on your attitude to risk.
What jamesd suggests is probably going to be best in most cases. But it's a lot of money, and your family's home, that's at risk if it all goes wrong.

Personally I do what jamesd suggests with about 5% of the mortgage repayment each month. So will benefit a little if it goes well, but won't be devastated if it doesn't.

jamesd

missprice wrote: »

Or you could just overpay the mortgage and not faff about. ... Keeping it simple is usually better.

Keeping it simple is very expensive, though. Probably, since there's always a chance that the investments won't work so well, very unlikely though that is over mortgage timescales.

Consider my own approach where I do the investing via a salary sacrifice pension. For various parts of my income I get this income tax and NI relief:

1. Higher rate income tax 40% plus higher rate employee NI of 2% plus 6.9% employer NI. Total 48.9% relief.
2. Higher rate income tax 40% plus basic rate employee NI of 12% plus 6.9% employer NI. Total 58.9% relief. This is salary sacrifice in basic rate range at a job plus higher rate taxable income from elsewhere.
3. Basic rate income tax 20% plus basic rate employee NI of 12% plus 6.9% employer NI. total 38.9% relief.
4. Also a range where the employer does 100% matching.

Add that lot to the likely investment gains and I'd probably lose hugely by overpaying on a mortgage compared to using pension contributions then using a pension lump sum to pay the mortgage.

Overpaying is simple and good for those where the age limitations on pensions don't work, because that can even be done without any investment risk, or for those who don't have the investment risk tolerance to use investments. It's just very expensive compared to the alternatives if they are viable and appropriate for the individual.

stephen6885

Hi,
I don't understand the maths against overpaying if it lowers your monthly repayment amount.
My situation:
approx £91K left to repay over 19 years.
Currently i repay £492 p/m.
this means a total repayment of £112,176 (228 months of repayments).
If i overpay, halifax reduce my monthly repayment amount.
Last time i overpayed £350 they lowered it by about £3.50.
£3.50 per month for 228 months is is a saving of £798.

£350 plus interest of 2.34% for 19 years comes to £530 (if my maths is right), so with that one payment i would have finished paying only 1 month earlier.

but i save more (£268) by them lowering the monthly repayments.

What have i missed?

Sheldon69

I've just re mortgaged 20 yr ( natwest) i have 2yr fixed rate nd can over pay, shud I wen I can nd shud it b lowering payments or term time??

Sorry in advance I'm knew not quite learnt how to do stuff on here yet!