Mortgage Overpayments - reduce debt vs reduce term (Martin Lewis podcast)

Gareth77

Hi

I assumed when you did mortgage overpayments you were simply reducing the amount of the loan, so when it came to the end of the fixed you had less of a loan and therefore your payments would be reduced vs if you hadn't (and if you overpaid enough you could counter the rate rise).

However....on the Martin Lewis podcast this week he seemed to allude to the fact that reducing the term would better when doing overpayments.

Did I hear this correctly? and do you have these options when doing overpayments?

He also seemed to say overpaying may not always be the best option, despite feeling like it is - you maybe better saving money and then taking that out to pay the difference.

Thanks in advanced!

amnblog

So that's where everyone on the Forum has gotten the idea from.

Pay as much as you can each month as soon as you can.

Newbie_John

Have a look at Natwest calculator which actually shows both options:
https://www.natwest.com/mortgages/mortgage-calculators/mortgage-overpayment-tool.html

Example - £250k mortgage, 20 years, 3% rate (we assume it will last forever) and we overpaying £50k.

1) Reduced term:
-Interest saving £34400
-Pay off 5 years quicker - so 15 years left
-Monthly payment £1386 - saving £0

2) Reduce rate
-Interest saving £16552
-Pay off 0 years quicker - so 20 years left
-Monthly payment £1109 - saving £277 monthly

Assumption is that £34k is greater than £16k but it's missing the point of what will you do with the £277 saved monthly over 15 years? If you keep putting it to a saving account you will acquire £50k over that time, if the saving account is at 3% forever then you will have £63k there - and that's how much mortgage you will have left after 15 years - which you could pay it off then in full making these two types actually equal.

Now you need to give one advice to all sort of people - some will deep into that pot and waste money buying an expensive watch - so better to go with option of reduced term.

But if you managed to save it in 4% saving account you would actually be £5k better reducing the rate, if at 2% you would be £5k worse.

Gareth77

OK thanks - I think I could save £1500 a month if I was very discipline.

The mortage says I can overpay 10% per CALENDAR YEAR - Mort is at 350K now, will be at 280K when the fixed finishes in 3 years time.

So it feels like I should do a savings account and make an over payment EVERY DECEMBER?

What I am confused about is - when I overpay do I pay of the loan or reduce the term? Ultimately I don't want my payments to shoot up in 3 years time. But from the above it sounds like I'll save more money reducing the term.  

Also when logging into Santander to do an overpayment I don't see the option to reduce payment vs reduce term?

TheAble

One point against reducing the term is that you may not be able to extend it again later if you fall on hard times. I'd personally rather have a lower monthly contractual obligation with the option to overpay as and when.

simon_or

I don't know how to explain it concisely but you can end up with the same interest rate savings whether you overpay and keep the term the same or overpay and reduce the term.

One situation where you might not be able to do that is if you hit the 10% overpayment allowance in the year in which case reducing the term would allow you to overpay by a little more.

As per the Santander website it looks like what they are saying is that regular overpayments will reduce term while lump sum overpayments will reduce monthly payment. But they also say that you can choose. I guess you need to call them and choose.

Newbie_John

Gareth77 said:

OK thanks - I think I could save £1500 a month if I was very discipline.

The mortage says I can overpay 10% per CALENDAR YEAR - Mort is at 350K now, will be at 280K when the fixed finishes in 3 years time.

So it feels like I should do a savings account and make an over payment EVERY DECEMBER?

What I am confused about is - when I overpay do I pay of the loan or reduce the term? Ultimately I don't want my payments to shoot up in 3 years time. But from the above it sounds like I'll save more money reducing the term.  

Also when logging into Santander to do an overpayment I don't see the option to reduce payment vs reduce term?

Ok so you want to make sure your monthly payment doesn't get too high in 2026. 
So you want to reduce monthly payments.

As simon_or mentioned above and I showed in example at the top - they could be equal if it comes to actual saving over the mortgage time - it's all down to you depending on what will you do with money saved each month.

If you reduce term your mortgage term - your monthly payments will go up in 2026.

When to overpay? Ask your bank for allowance each year, and when you hit that 10% - overpay, but if you reach it in March - wait till December :-) 

Also, if you can save £1500 a month you're likely on a higher tax - so keep in mind that you may need ISAs etc.

jrawle

But if you managed to save it in 4% saving account you would actually be £5k better reducing the rate, if at 2% you would be £5k worse.

What you describe isn't reallty a real world example. However, sticking with it, if you had a mortgage rate of 3% for the term and a savings account paying 4%, you'd be better off not overpaying at all, and putting the £50k lump sum into the savings accuont. Even if you have to pay basic rate tax on it, you'd still be winning.

Newbie_John

jrawle said:

But if you managed to save it in 4% saving account you would actually be £5k better reducing the rate, if at 2% you would be £5k worse.

What you describe isn't reallty a real world example. However, sticking with it, if you had a mortgage rate of 3% for the term and a savings account paying 4%, you'd be better off not overpaying at all, and putting the £50k lump sum into the savings accuont. Even if you have to pay basic rate tax on it, you'd still be winning.

I only talked about initial one-off overpayment - later in time using the saved £277 monthly - if mortgage rate is 3% and saving account pays 4% it's better to save - meaning that the initial decision of overpaying many years earlier with reduced rate was better than reduced term - contradicting the podcast.

jrawle

Newbie_John said:

jrawle said:

But if you managed to save it in 4% saving account you would actually be £5k better reducing the rate, if at 2% you would be £5k worse.

What you describe isn't reallty a real world example. However, sticking with it, if you had a mortgage rate of 3% for the term and a savings account paying 4%, you'd be better off not overpaying at all, and putting the £50k lump sum into the savings accuont. Even if you have to pay basic rate tax on it, you'd still be winning.

I only talked about initial one-off overpayment - later in time using the saved £277 monthly - if mortgage rate is 3% and saving account pays 4% it's better to save - meaning that the initial decision of overpaying many years earlier with reduced rate was better than reduced term - contradicting the podcast.

I know what point you were making. But it's still the case that your hypothetical person with £50k would be better to put it straight into a savings account at 4%, rather than paying £50k off their 3% mortgage then putting £277 from reduced mortgage payments into a 4% account each month. In other words, you should neither overpay the mortgage and reduce the term, nor overpay and reduce monthly payments.

Newbie_John

jrawle said:

Newbie_John said:

jrawle said:

But if you managed to save it in 4% saving account you would actually be £5k better reducing the rate, if at 2% you would be £5k worse.

What you describe isn't reallty a real world example. However, sticking with it, if you had a mortgage rate of 3% for the term and a savings account paying 4%, you'd be better off not overpaying at all, and putting the £50k lump sum into the savings accuont. Even if you have to pay basic rate tax on it, you'd still be winning.

I only talked about initial one-off overpayment - later in time using the saved £277 monthly - if mortgage rate is 3% and saving account pays 4% it's better to save - meaning that the initial decision of overpaying many years earlier with reduced rate was better than reduced term - contradicting the podcast.

I know what point you were making. But it's still the case that your hypothetical person with £50k would be better to put it straight into a savings account at 4%, rather than paying £50k off their 3% mortgage then putting £277 from reduced mortgage payments into a 4% account each month. In other words, you should neither overpay the mortgage and reduce the term, nor overpay and reduce monthly payments.

You're right with "don't overpay" approach it works for typical person, but not higher tax payers.

For 20% tax payer, £50k on 4% makes £2000 interest, after £200 tax = £1800 - so still decent 3.6%.
For 40% tax payer, £50k on 4% makes £2000 interest, after £600 tax = £1400 - so just 2.8%..