Unsure what to do...

coolasacucumber

I bought a Kia on finance in May this year.


5 years, 5.4% APR. £10,500, minus £1,000 deposit.
60 repayments of £180.46.
Total charge for credit is £1,327.60
I've made 4 payments, so have 56 to go.


No problem with that, went through a spate of unreliable cars, so very much appreciating having a decent one now!


I have no other debt.


Just found out that I will be inheriting £45/£50k sometime in the next 12 months.


First thoughts are that I would like to use that as a deposit to buy a house.


But - rattling around my head is that maybe I should be paying off the finance first, then using what's left for a house.


I've checked the finance documents, these seem to be the relevant points:-


2.5 - You may repay all amounts payable by you under this agreement early, either in part or in full, which may include a rebate.


2.6 - If you repay the amount of credit early, in part, under clause 2.5 above we may reduce the repayments in order to preserve the duration of this agreement and will notify you of the new repayments in writing.


Can anyone offer any suggestions or things for me to consider?


Thanks in advance for your consideration.

Linton

What is the rebate if you pay the debt off early?

In principle I would pay off the debt and resolve in the future to buy a car with saved/invested cash. However if you dont actually get most of the contracted interest rebated then it wont be worth it.

guymo

Repaying early looks like a good idea, but it may depend on what kind of a mortgage you have in mind. Perhaps having the extra £10k towards your house will let you access a better value mortgage, by reducing the loan-to-value ratio. I just had a quick look on first direct, and their rates change by 0.6 when you get from 90% to 85% LTV.

So e.g. if you are buying a house at £260k and have £40k cash, your choice may be between:

- paying off the car, and borrowing £230k at 4.2%
- not paying off the car, and borrowing £220k at 3.6%, plus the loan of £10k at 5.4%

In this case it's better not to pay off the car, because the saving of 0.6% on £220k outweighs the 5.4% you're paying on the car loan.

I'm ignoring things like the risk that you don't make a payment in the above.

guymo

Linton wrote: »

What is the rebate if you pay the debt off early?

In principle I would pay off the debt and resolve in the future to buy a car with saved/invested cash. However if you dont actually get most of the contracted interest rebated then it wont be worth it.

The amounts that can be charged for early repayments are extremely limited these days. I believe that for sums under £8000 it is not possible to charge anything. Otherwise it's 1% of the early repayment amount -- quite negligible.

https://www.moneyadviceservice.org.uk/en/articles/cut-your-car-finance-hire-purchase-and-other-finance-costs

averageish

Am I missing something here? Why would anyone settle the car loan under these circumstances unless mortgage affordability was an issue or you wanted a shorter term mortgage of less than 20 years..?

I would keep the car finance agreement if you can get a mortgage agreement with it in place. The additional £10k deposit will save you a fortune over the life of the mortgage (I'm assuming 20 year term) and may enable access to a better mortgage deal to boot.

Time to get out the mortgage calculator, but this is a no brainer.

Example:

200k mortgage at 2.5% over 20 years - £254k
190k mortgage at 2.5% over 20 years - £241k

So, in the above example, once you take off the interest you paid for the car loan, thats roughly £11,700 you've saved by keeping the car vs. paying it off.

A longer mortgage term means much more interest, so you will save even more. Additionally, you will not get 2.5% on your mortgage for the full term, the interest rate will climb much higher, so the savings are liable to be far more substantial.

Rough guess, by keeping the car finance and using the £10k as deposit you'll save around £30k over the term of your mortgage!

Linton

averageish wrote: »

Am I missing something here? Why would anyone settle the car loan under these circumstances unless mortgage affordability was an issue..

I would keep the car finance agreement if you can get a mortgage agreement with it in place. The additional £10k deposit will save you a fortune over the life of the mortgage (I'm assuming 20 year term) and may enable access to a better mortgage deal to boot.

Time to get out the mortgage calculator, but this is a no brainer.

Example:

200k mortgage at 2.5% over 20 years - £254k
190k mortgage at 2.5% over 20 years - £241k

So once you take off the interest you paid for the car loan, thats roughly £11,700 you've saved by keeping the car vs. paying it off.

A longer mortgage term means much more interest, so you will save even more. Additionally, you will not get 2.5% on your mortgage for the full term, the interest rate will climb much higher, so the savings are liable to be far more substantial.

Rough guess, by keeping the car finance and using the £10k as deposit you'll save around £30k over the term of your mortgage!

The OP could use the money he no longer needs for the car repayments to overpay on the mortgage. So in those circumstances its simply the difference between 5.4% on the car and 2.5% on the mortgage.

However if Guymos figures are relevant to the OPS situation then that may well be different. On the other hand could the car loan reduce the mortgage available?

averageish

Linton wrote: »

The OP could use the money he no longer needs for the car repayments to overpay on the mortgage. So in those circumstances its simply the difference between 5.4% on the car and 2.5% on the mortgage.

However if Guymos figures are relevant to the OPS situation then that may well be different. On the other hand could the car loan reduce the mortgage available?

Linton this is true at a fixed 2.5%, but the interest rate on the mortgage can (and will) rise, unlike the car loan. Shaving £10k off from day one will save him far more than £1,300k in the long run and provides a hedge against interest rate rises whilst also reducing the risk of negative equity in the event of a declining property market.

coolasacucumber

Some excellent points to consider there, thank you!


To give a rough idea, I'd be looking, more than likely, of spending no more than c.£100k on a house, so would potentially have 50% deposit.


Does that alter any of your advice?


Many thanks again.

averageish

coolasacucumber wrote: »

Some excellent points to consider there, thank you!


To give a rough idea, I'd be looking, more than likely, of spending no more than c.£100k on a house, so would potentially have 50% deposit.


Does that alter any of your advice?


Many thanks again.

The numbers need to be crunched and it's fairly easy to do with MSE's own mortgage calculators.

What mortgage deal are you looking at and over what term?

coolasacucumber

As it's all relatively recent news, I've not had much chance to look at mortgages.


I guess I need to decided whether I want to have small monthly repayments over a longer time, or crank them up and pay it off sooner. I'm 'only' 32, so would be able to get a 25 year term I imagine.

guymo

averageish wrote: »

Time to get out the mortgage calculator, but this is a no brainer.

Example:

200k mortgage at 2.5% over 20 years - £254k
190k mortgage at 2.5% over 20 years - £241k

For the sake of the argument, let's compare the following two situations that OP might get into

1) 200k mortgage fixed at 2.5% over 20 years, car loan paid off
2) 190k mortgage fixed at 2.5% over 20 years plus £10k loan at 5.4% over 5 years.

In (1), my calculations show a monthly payment of £1059.81, so £63588 over the first five years, and £158942 mortgage outstanding at that point.

In (2), the monthly mortgage payments are £1006.82, costing £60409 over the first five years, with £150994 outstanding. There is also the loan to pay off, which costs £11433. So over five years you'll pay £71842 and end up owing £150994.

This means that in option (2) you pay £8254 more over five years in exchange for owing £7948 less. This is worse than (1), so on pure arithmetic you should pay off the car loan.

You don't need to do these detailed calculations, though. As Linton said, 5.4 > 2.5 so pay off the loan; but there may be other considerations as we've discussed.