Overpay Vs Reduce Term - the maths, are they the same? (HSBC won't allow reduce term)

Squirrel60

Hello,

I'm confused by some of the wording in an article on this site but I'm not allowed to post links, so it's called "Should I overpay my mortgage? It's a question of whether you save, or whether you overpay your mortgage" last updated in July, by Martin and Team

"When you make an overpayment, your lender may offer you two options:

• Either to reduce next month's payment by the amount you've overpaid, or 
  
  
• To keep payments the same and reduce your mortgage term instead.

This is something to watch for – if you get it wrong, it means your overpayment won't actually help you out that much. If you get this choice always, always tell your lender you want to reduce the term of your mortgage.

If your overpayment goes to reduce next month's payment, it just means you're paying slightly early, so you save a few days' interest, but not much. You'd still repay almost as much as you would sticking to contractual payments, and – crucially – you won't have reduced your mortgage term.

Be very clear that you want all future overpayments to reduce the term of your mortgage. Once you've agreed this, you can usually make overpayments through online banking by setting your mortgage account up as a new payee, then making payments as and when you wish. Or, if you want to overpay the same amount every month, you can set up a standing order."

So that seems a very clear case for having the overpayment reduce the mortgage term....yet moments later in the article it says this:

"Decreasing the term sounds sensible, and does almost exactly the same job that overpaying does – both mean you pay more each month, you pay less interest, and your mortgage is paid off sooner."

So first part makes it sound like all the benefit is with making sure they reduce your term and if you don't you're actually doing it wrong - then the 2nd part says it's basically the same....so which is it?!

Can someone explain the mathematical difference please?  I have no other debts, my mortgage % is higher than I can get on my savings, I can pay off a lump sum and still keep enough back for a safety net, I'm already at less than 50% LTV so can't move into a better bracket, unlimited overpayments allowed, no ERC etc. etc. so it's really about maximizing the impact of overpayments. 

I read on the HSBC website that overpayments default to reducing the term of the mortgage, I made a £10k overpayment and to my surprise found my next mortgage payment was less.  Spoke to them and they said as I was on a lifetime tracker it's calculated daily and they just change the interest on the amount left and keep the term the same (have 19 years left), and every time the base rate changes they recalculate over the same remaining term - I cannot reduce the term. 

I have another £40k I can chuck at it as well as monthly overpayments going forward but I'm wary now that maybe I'm not understanding some fundamental maths that I thought I did (as I used the MSE overpayment calcs). Surely if I keep overpaying I'm reducing the term because I'm clearing the capital debt, and it will just end up silly with £100 left with interest calculated over the remaining 15 years by that point...and then I'll just clear the balance and it will end.  Or is there some interest effect I'm missing? Sorry I thought this was simple but I've ended up doubting myself - would appreciate some advice from clearer mind than mine! TIA

Newbie_John

If you have mortgage for 19 years with fixed rate of 5% for 19 years and available saving account/ISA with 5% - overpaying by either reducing monthly payment, rate, or not overpaying but keeping in savings account and paying your mortgage in full when you get there is the same.

Overpaying with reduced rate vs term is also a bit similar if the money you save monthly (you pay less) you put to saving account - rather than spend on a new car etc.

The logic presented in the article you quoted comes from days where mortgage rates were higher than savings account - and it made more sense then. Especially when you reduce term, you pay less interest long term - but again this is based on assumption you won't have money saved to pay off your mortgage quicker in the future. If you paid money towards mortgage they are not accessible anymore, if you put them to savings, reduce monthly payments - you can use them for other things - and as you're giving one advice to everyone it was safer to say - overpay and reduce term.

But as of now it's more complicated - but the main rule is if you are sure you won't touch the saved money - choose what has higher % - either saving accounts or overpayment.

Monthly payments or term? Let's imagine rates get to 10% when you will be switching products next - if you reduced term - your monthly payments will get much bigger, if you reduced monthly payments - they won't jump as much.

All in all, they can be the same either way.

Newbie_John

Or simple example to look at it - we have 100k mortgage for 10 years, we assume the rate will always be 5% and there always will be 5% saving account available. We have £8000 spare. Our monthly payment is £1061.

1) We overpay and reduce term:
We still pay £1061 monthly. Our mortgage is now 9 years long. After one 1 year we have £83683 left to pay.
2) We overpay and reduce monthly payment:
We now pay £976 monthly. Our mortgage is still 10 years long. After one 1 year we have £84725 left to pay.
3) We save all of that.
We still pay £1061 monthly. Our mortgage is still 10 years long. After one 1 year we have £92092 left to pay.

If in step 2 we save our £85 in 5% saving account after a year we will have = £1045.50 after a year.
If in step 3 we save our £8000 in 5% saving account after a year we will have = £8400 after a year.

The values above are the actual differences between 3&1 and 2&1.

fewcloudy

Squirrel60 said:

Hello,

I'm confused by some of the wording in an article on this site but I'm not allowed to post links, so it's called "Should I overpay my mortgage? It's a question of whether you save, or whether you overpay your mortgage" last updated in July, by Martin and Team

"When you make an overpayment, your lender may offer you two options:

• Either to reduce next month's payment by the amount you've overpaid, or 
  
  
• To keep payments the same and reduce your mortgage term instead.

This is something to watch for – if you get it wrong, it means your overpayment won't actually help you out that much. If you get this choice always, always tell your lender you want to reduce the term of your mortgage.

If your overpayment goes to reduce next month's payment, it just means you're paying slightly early, so you save a few days' interest, but not much. You'd still repay almost as much as you would sticking to contractual payments, and – crucially – you won't have reduced your mortgage term.

Be very clear that you want all future overpayments to reduce the term of your mortgage. Once you've agreed this, you can usually make overpayments through online banking by setting your mortgage account up as a new payee, then making payments as and when you wish. Or, if you want to overpay the same amount every month, you can set up a standing order."

So that seems a very clear case for having the overpayment reduce the mortgage term....yet moments later in the article it says this:

"Decreasing the term sounds sensible, and does almost exactly the same job that overpaying does – both mean you pay more each month, you pay less interest, and your mortgage is paid off sooner."

So first part makes it sound like all the benefit is with making sure they reduce your term and if you don't you're actually doing it wrong - then the 2nd part says it's basically the same....so which is it?!

Can someone explain the mathematical difference please?  I have no other debts, my mortgage % is higher than I can get on my savings, I can pay off a lump sum and still keep enough back for a safety net, I'm already at less than 50% LTV so can't move into a better bracket, unlimited overpayments allowed, no ERC etc. etc. so it's really about maximizing the impact of overpayments. 

I read on the HSBC website that overpayments default to reducing the term of the mortgage, I made a £10k overpayment and to my surprise found my next mortgage payment was less.  Spoke to them and they said as I was on a lifetime tracker it's calculated daily and they just change the interest on the amount left and keep the term the same (have 19 years left), and every time the base rate changes they recalculate over the same remaining term - I cannot reduce the term. 

I have another £40k I can chuck at it as well as monthly overpayments going forward but I'm wary now that maybe I'm not understanding some fundamental maths that I thought I did (as I used the MSE overpayment calcs). Surely if I keep overpaying I'm reducing the term because I'm clearing the capital debt, and it will just end up silly with £100 left with interest calculated over the remaining 15 years by that point...and then I'll just clear the balance and it will end.  Or is there some interest effect I'm missing? Sorry I thought this was simple but I've ended up doubting myself - would appreciate some advice from clearer mind than mine! TIA

Given all you have said, you have nothing to worry about.

HSBC might not "allow" you to reduce the term, but that happens by default anyway.

Your mortgage payment may have been less after you paid them £10k, because that's the way HSBC work. My old Alliance & Leicester (now Santander) was exactly the same. Every change to the rate, a letter arrived informing me of new (minimum) monthly payment. Unlimited overpayments, no ERC etc so I overpayed by about 4 x as mucha s they asked for, and the term reduced by default until there was no balance left to pay.

So in your case the term shortens to whatever you make it by paying off the mortgage. Basically you are correct in all you are saying and thinking of doing.

Newbie_John

Squirrel60 said:

Surely if I keep overpaying I'm reducing the term because I'm clearing the capital debt, and it will just end up silly with £100 left with interest calculated over the remaining 15 years by that point...

Once your fixed period ends and you go to standard variable rate - then you can literally pay off your mortgage in full.
Based on my examples above if you hit the moment when your savings reach the amount owed - you can just pay it off in full - so you will never really hit the moment of £100 left with 15 years of interest remaining.

Squirrel60

Thank you very much for all the fast responses! what a great forum

I should perhaps separate key detail from my long post.  My question is purely about ensuring I am not losing out by making overpayments (both lump and regular) when as a result of these my lender will not reduce the mortgage term, instesd only reduce the monthly payment. It's not about comparable savings etc.

I am on a lifetime tracker pegged to BoE base rate so I don't intend to move deals as I have no ERCs or overpayment restrictions with this deal (nor the need for remortgage, valuation fees etc).  All being well I hope to repay my mortgage in the next 3-4 years using overpayments.

My concern is am I losing out with HSBC who will not reduce the term when I make an overpayment, they instead reduce my monthly payment - is this somehow causing me to incur more interest by it being calculated over 19 years as the term doesn't shorten? My mind tells me it is a moot point if, and there would be no advantage of moving to another lender on a fix for say 3 years who do shorten the term upon overpayment.  Does either method incur greater interest, assuming both mortgages are paid off in 3 years?  It feels like when you stare at 2+2 long enough you start to doubt if it does = 4! sorry!  I think fewcloudy is confirming from their experience with a tracker it makes no difference, I would hate to pay in the rest of my lump some and misunderstand the mechanics!

MWT

Squirrel60 said:

My question is purely about ensuring I am not losing out by making overpayments (both lump and regular) when as a result of these my lender will not reduce the mortgage term, instesd only reduce the monthly payment

My concern is am I losing out with HSBC who will not reduce the term when I make an overpayment, they instead reduce my monthly payment - is this somehow causing me to incur more interest by it being calculated over 19 years as the term doesn't shorten?

As explained above leaving the term the same is only a problem if you only pay the reduced monthly amount they calculate over that term.

If you keep the total monthly payment including your overpayment at the same level then inevitably you will reach the end of the mortgage before you get to the end of the term...

The interest you will actually pay is calculated daily as you make each payment, the term only matters when they are recalculating how much you need to pay to complete the repayments by the end of the term, this reduces the payment they need each time you overpay, just ignore their lower number and keep overpaying...

Squirrel60

Thanks, I think the piece that wasn't clicking for me was that bit about not subsequently paying only the revised lower monthly amount from HSBC - because that never crossed my mind, as that's not overpaying! I was always going to pay my original monthly commitment + a variable overpayment....not reduce my monthly payment to match their new smaller one, because that is not overpaying and of course would keep me paying for another 19 years! Thanks for the clarifications.