Why do we pay so much interest at the start ? 30 August 2007 at 10:57AM in Mortgage-free wannabe 15 replies 1.2K views

Mad101daN

Title says it all really, how come we pay alot of intrest at the start why is it not spread evenly over the term ?

Is it cos banks are bast*rds (probably) or is there a more logical reason.

Cheers

Dan

ps You can use this calc to see how much you pay in intrest a month.

http://www.loanbright.com/edirectlending/calc_amortization.html

Mad101daN

Doh, I think it just came to me, as the loan is payed off, the interest we need to pay on it goes down.

Im guessing this is right, sorry for being a bit fic.

raino144

No question is silly (unless meant that way!)

Interest is calculated as a % on the outstanding balance and will change over the life of a loan.

Monthly payments are calculated to take account of all the interest outstanding (for that month) and also a bit of the capital you borrowed. If interest rates (and your payment) stays the same, the interest part of your payment will get smaller and the capital part of your payment will get bigger as time goes on, because the capital amount owed will reduce as you pay it off.

All that being said, the more you can pay off sooner, the more interest you will save!

Martinslovechild

With a capital repayment mortgage, the monthly payments made in the early years are predominately interest. However, in the later years this is switched and the payments off your mortgage are increased even though your monthly payment will not (depending on interest rates increasing / decreasing).

This graph hopefully provides an insight...

Martinslovechild

By the way - as I've said in my other thread, there's really no good reason why a mortgage should be 25 years duration other than that's what people expect.

What I would urge each & every one of you to do is to determine the maximum amount you can afford to pay each month towards your mortgage (use Martin's Budget Planner to assist you) and set up a mortgage where the monthly amount is approximately this amount. You'll probably find that you can clear your mortgage in double-quick time.

For example, let's assume you're currently paying £500 per month on your mortgage but could easily afford £700. First check that your bank allows you to make monthly overpayments (or if they don't, deposit the £200 difference in a cash ISA or savings account instead to pay into the mortgage at a later date when you change your deal).

If your bank won't allow overpayments, ask about reducing the term (i.e. increasing your monthly payment up to the £700 level).

You'll be amazed at the amount you can save...


Here's an example.

Mortgage Balance = £80,000
Interest Rate = 5.75%
Monthly Cost = £503.29
Term = 25 years

Now, if we add the magic £200 ingredient...

Mortgage Balance = £80,000
Interest Rate = 5.75%
Monthly Cost = £503.29 + £200 overpayment = £703.29
Term = 13.7 years

In other words, simply paying an extra £50 per week slices 11.3 years off this mortgage!!


To calculate figures for your own mortgage, try this Mortgage Calculator.

Dithering_Dad

...and that £50 per week could be made up from getting rid of Sky and using Freeview, no more visits to Starbucks, making your own packed lunch, finding the cheapest gas, electicity, phone and internet supplier, walking instead of using the car for small journeys, reducing the grocery bill by shopping around, etc, etc.

You can reduce your mortgage term by 11.3 years without reducing your standard of living!

dzug

Dithering_Dad wrote: »

...and that £50 per week could be made up from getting rid of Sky and using Freeview, no more visits to Starbucks, making your own packed lunch, finding the cheapest gas, electicity, phone and internet supplier, walking instead of using the car for small journeys, reducing the grocery bill by shopping around, etc, etc.

You can reduce your mortgage term by 11.3 years without reducing your standard of living!

Um yes I do all that already.....
I know what you mean though

(Mortgage free)

tsharp

I currently have £100ish in a Nationwide ISA -which i don't regularly contribute to - and a mortgage with Nationwide. I am beginning to think i should transfer that ISA money to the mortgage as an over payment, esp as I have an online savings account which is getting deposited to regularly.

At the moment, the ISA is a higher interest account than the mortgage is currently, but that will change when the rate changes. Right now i see little benefit to the £100 in the ISA. What are your thoughts?

Martinslovechild

tsharp wrote: »

At the moment, the ISA is a higher interest account than the mortgage is currently, but that will change when the rate changes. Right now i see little benefit to the £100 in the ISA. What are your thoughts?

As a (very) rough guide, a £100 overpayment into a mortgage saves approximately £100 in interest charges over a full 25 year term. You haven't said how far into your mortgage term you are, but whilst your intentions are good, a one-off £100 payment will not make a massive difference to your mortgage.

Why not consider throwing £100 per month at your overpayment fund? - that would make a big difference. You'll never miss £25 per week and you'll chop a few years off your mortgage.

Also - if your mortgage rate is, let's say, 5.75% and you're investing in a cash ISA paying 6%, then believe it or not you'll actually be better off overpaying into your mortgage.

Here's the maths:

Cash ISA = 6.0% Gross
Mortgage Overpayment = 5.75% net = 7.19% gross [basic-rate taxpayer]
Mortgage Overpayment = 5.75% net = 9.58% gross [higher-rate taxpayer]

This is because you're choosing NOT to receive interest on your money in the overpayment fund, you instead earn an effective gross rate of 7.19% or 9.58%. Not bad eh?

Hereward

Martinslovechild wrote: »

Also - if your mortgage rate is, let's say, 5.75% and you're investing in a cash ISA paying 6%, then believe it or not you'll actually be better off overpaying into your mortgage.

Here's the maths:

Cash ISA = 6.0% Gross
Mortgage Overpayment = 5.75% net = 7.19% gross [basic-rate taxpayer]
Mortgage Overpayment = 5.75% net = 9.58% gross [higher-rate taxpayer]

This is because you're choosing NOT to receive interest on your money in the overpayment fund, you instead earn an effective gross rate of 7.19% or 9.58%. Not bad eh?

You're forgetting that the Cash ISA is tax free to; therefore, the equivalent rates for the ISA are 7.5% (basic) and 10% (higher). You would be slightly better off leaving your money in the cash ISA at this point, until its rate is lower than your mortgage rate.

tsharp

Cheers, mortgage rate is 4.89 atm, but in just over a year it will be god knows what...

Making regular overpayments each month is the best way to go i think, plus the £100 ISA gives me (at least psychologically) base to save from.