Overpayment strategy; loan vs mortgage

Rob.C

Hi,
Looking for someone to sanity check my logic...

I recently took a loan out for £25k for some home improvements. When I applied I was accepted only for an 8.9% APR, meaning a total interest charge of £5815.40 over a 5 year term
Our mortgage is currently £225,000 with 21yrs 7 months left at 2.19% APR which I have been overpaying by £200 per month to save as much interest as I can

Moving forwards, I'm able to spare another £300 a month to overpay the loan or my mortgage. This made me question what strategy is best for overall interest savings, for example...

Assuming I allocate the £500 monthly spare income as follows:
Mortgage overpayment: £0
Loan overpayment: £500
= loan paid off 32 months earlier, within 28 months of the original 60

Over the 5 year initial loan term, that means I will have overpaid the mortgage 28 months x £0, then 32 months x £500 = £16,000 total mortgage overpayment
Paying the loan off 32 months early saves £3363 in interest

Compare this with splitting the spare £500 between mortgage and loan across the term of the loan:
Mortgage overpayment: £200
Loan overpayment: £300
= loan paid off 25 months earlier, within 35 months of the original 60

Over the 5 year initial loan term, that means I will have overpaid the mortgage 35 months x £200, then 25 months x £500 = £19,500 total mortgage overpayment
Paying the loan off 25 months early saves £2607 in interest

Everything I've read online suggests focussing on the debt with the highest interest rate first, though this doesn't seem to take into account the term of the debt (in this case the mortgage) which will realise greater interest savings overall; even within 5 years that the loan runs vs the full term that's left.

In summary, does it make most sense to simply plough all £500 into overpaying the mortgage and letting the loan run it's natural course?

Thanks,
Rob

Rob.C

NB - I realise this doesn't take into account adding the minimum loan payments (£513) onto my mortgage overpayments once the loan is settled, which I believe is the snowball method. 
Modelling it with that, it does make sense to pay the loan off ASAP; so if my maths is correct it depends whether or not you use *all* the released income once the loan is settled or not.

MalcRH12

Overpaying the loan will result in higher interest savings compared to the mortgage so plough as much spare cash as you can into that. You will only save 2.19% in interest on the amount overpaid on the mortgage compared to 8.9% on the amount overpaid on the loan

TheAble

It's all about the interest rate. Hence you should throw all at the loan.

Rob.C

Thanks for the feedback. The trouble I have with that logic is that it doesn't take into account the balance owed, nor the term. I.e. even though 2.19% is less than the loan rate of 8.9%, it is 2.19% of £225,000 and over 20+ years so the overall interest will of course be much higher.

The only counter argument I can think is that as the loan only runs for 5 years on it's standard term I have less time to reduce the interest owed on it vs the mortgage, which I can offset over the longer term with larger overpayments once the loan is settled.

ryanm8655

I understand where you’re coming from but think the logic is flawed. You’ve got the opportunity cost of the loan repayments to account for, which you’ll then be able to plough into your mortgage if you clear it early, plus you can whack that c.£3k in interest saved onto the mortgage as well. 

By clearing the loan early you’ll be able to overpay by more and catch up with where you would’ve been.

Clear the loan.

If you think about option 1, you’ll have lost out on 28 months x500 of mortgage overpayments but gained 32 months x £515 loan repayments. Even taking into account the interest on the mortgage over those 28 months, you’re better off at the end of the loan term. 2% of £6k a year is £120.

DrEskimo

The term and amount is irrelevant. All that matters is the APR.

The interest saving comes from the amount you repay, not the amount that is still owed.

enthusiasticsaver

Clear the loan as it is a higher interest rate.  The term is irrelevant as DrEskimo says.  Once the loan is gone then overpay the mortgage. 

enthusiasticsaver

If you put  the loan details into an overpayment calculator by repaying £500 extra each month you will clear the loan in 28 months and save £3363 in interest. 
The interest on £6000 (by directing the overpayments to the mortgage) at 2.19 is only £131.40 so the most you will save each year is that. It will be less than that as obviously the £500 will be paid monthly rather than all in one go. 

Rob.C

Thanks all. The confusion for me here is the interest saved on the mortgage. Is Santander's overpayment calc doing something sneaky? A one-off payment of £500 projects an interest saving of £292.83 alone

[Deleted User]

It's not sneaky.  The saving is a result of the capital being lower - hence less interest.