Mortgage vs Loan

ShireSaver

Hi guys,

I hope you can help with a question relating to mortgages and a loan, and the most cost-effective way of paying them back. It's a brainteaser, and more of a logic puzzle than anything else. You'd settle an argument if anyone has a definitive answer!

Please consider the following scenario (figures changed to avoid disclosing personal circumstances):

• Mortgage owing: £150K
• Loan owing: £5k, 3yrs to run at 5%
• We're about to re-mortgage at 2% over 5 years

Which of the two scenarios is the best approach, assuming the amount we outlay each month is the same in each scenario (i.e. mortgage+ loan or mortgage + savings):

1. Keep the loan separate and continue to pay for 3yrs, whilst re-mortgaging for £150k
2. Add the loan to the mortgage, but save extra into a bank account to pay off a lump sum after 5yrs

For completeness, all other factors are the same i.e. interest rates remain the same in both scenarios, no LTV or affordability considerations. We will definitely save money to a bank account in scenario 2, and there'd be no early repayment fees etc, we're just trying to get our heads around the best approach.

Any advice welcome!

AnotherJoe

Without doing the maths in detail, adding to the mortgage is better since it's either (loan) 3 years at 5% = 15% or (mortage) 5 years at 2 % = 10%.

The 15% will be lower in reality because each year the amount owing will be lower, but you can remove the 10% altogether because on an amount of £5k you can get around 2% interest by picking and choosing bank accounts to save in carefully.

So it's a difference of either somewhat less than 15% (loan) or zero (mortgage and save the lump sum to repay).

ShireSaver

Thanks for your comment, it's appreciated.

We weren't sure if adding the loan to the mortgage (scenario 2) would mean we weren't paying off as much of the mortgage principal, and therefore incurring more interest on the mortgage side.

It's difficult to put the scenarios into a mortgage calculator and isolate the 5yrs - they usually give you totals for the mortgage duration - 25yrs or whatever.

We thought it'd be interesting to know other people's thoughts - if 5 people chimed in "it's a no-brainer, scenario x is the way to go" we'd have a better idea. Thanks again for your comment!

AnotherJoe

ShireSaver wrote: »

Thanks for your comment, it's appreciated.

We weren't sure if adding the loan to the mortgage (scenario 2) would mean we weren't paying off as much of the mortgage principal, and therefore incurring more interest on the mortgage side.

It's difficult to put the scenarios into a mortgage calculator and isolate the 5yrs - they usually give you totals for the mortgage duration - 25yrs or whatever.

We thought it'd be interesting to know other people's thoughts - if 5 people chimed in "it's a no-brainer, scenario x is the way to go" we'd have a better idea. Thanks again for your comment!

Well, thats true, you wont be, but the key point to me is its going to be a marginal difference, its only 3% more and in the early stages of a mortgage you arent paying off much principal anyway so it wont make a lot of difference.

Its all fairly marginal anyway, its a £5k loan and the difference between 5% and 2% interest is about £400 over 5 years eg less than £2 a week.

The £5k will cost you £260 at 2% over 5 years, and maybe you can get that back by saving the repayment equivalents into a higher interest account, whereas thats not really possible with a 5% loan, you cant "out-interest" that in a higher interest account.

So you'll save £400 plus whatever of the £260 you can "offset" by saving the repayments needed into an higher interest account and paying off after 5 years. Or you could do it exactly by just overpaying the mortgage by the exact amount you'd pay on a loan at 2% for 5 years, (a bit under £90 a month according to a loan calculator)

ShireSaver

Thanks again - adding it to the mortgage looks like it's worth doing then. £400+ is worth a couple of forum posts and rejigging the loan! I appreciate your advice, thanks :beer:

getmore4less

Just set a calculator to interest only and plug in your payment, see how much you owe in 5 years.

getmore4less

Don't save the money unless you can can get a better net rate than the mortgage, overpay.

ShireSaver

getmore4less wrote: »

Don't save the money unless you can can get a better net rate than the mortgage, overpay.

Good point, thanks. I'll look into whether the new mortgage allows overpayments.

getmore4less

The £150 loan payment used to pay the larger mortgage will save £235 over the 3 years of the loan.