Please help me decide on early repayment

Bristol_Lives

Hi,

I have loan of 223,000 for 35 years period. Interest rate is 4.26% and fixed for next 5 years.
Early repayment charges (ERC) are 5% for next 2 years, then 3% for 2 years and 1% for next 1 year. Lender allows 10% overpayment without any charges. 

I have managed to secure some money, about 100,000, and was wondering whether shall I pay loan with 5% ERC or pay only 10% extra each year. How do I know it is worth paying 100,000 now? I guess, i can get like 4.5% interest on saving if I decide to save till ERC comes down. Any ideas and calculators or methods to figure out whether it is worth paying ERC? 

Thank you.

moneysaver1978

In case you haven't seen this: https://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator/ - this might be what you were looking for?

moneysaver1978

There's also https://www.locostfireblade.co.uk/spreadsheet/Index.html (linked from MSE somewhere) which we thought was great to compare between two rates/scenarios.

Mark_d

As long as you are comfortably managing repayments on you outstanding £223k then it is generally not worth making overpayments.  The reason is that is that you can easily achieve a better net return on your £100k than the 4.26% you pay on your loan.

The rate of return on Premium Bonds is 4.4% tax free.  With a S&S ISA I expect an annual return of 6%-10% over the long term, and you'd get something similar by putting money into your pension.

tacpot12

I've modelled the options of using the £100K and paying this amount off the loan immediately (with a 5% ERC) and paying 10% extra every year and assuming you get 4% interest on the money you haven't yet paid off. (I didn't account for tax on the interest, but you can probably do better than 4% interest)

Aassuming you keep the monthly payments the same and the interest rate remains the same after your fixed rate ends, then:

In the first case, it reduces the mortgage term to 15 years and 4 months and you pay about £54K in interest (originally you would have paid £206.5K in interest! So it's a massive saving of interest). 

In the second case, it reduces the mortgage term to 14 years and 5 months and you pay a total of £60K in interest. (So more interest than in the first case, but you clear the mortgage quicker which is probably of greater value  to you).

This difference holds true regardless of whether your interest rate goes up or down after the fixed rate ends. Paying immediately saves the most interest, paying in stages saves more time off the mortgage, but there is not a great deal of difference. 

If it was me, I would pay 10% each year. 

I used the Excel Loan Amortization template to model these options. 

badmemory

There is one other aspect to this.  Are you sure if you pay off only 10% that you won't decide to go & buy a flash new car.  Unlikely I know but should be considered.

Yorkie1

Bristol_Lives said:

Hi,

I have loan of 223,000 for 35 years period. Interest rate is 4.26% and fixed for next 5 years.
Early repayment charges (ERC) are 5% for next 2 years, then 3% for 2 years and 1% for next 1 year. Lender allows 10% overpayment without any charges. 

I have managed to secure some money, about 100,000, and was wondering whether shall I pay loan with 5% ERC or pay only 10% extra each year. How do I know it is worth paying 100,000 now? I guess, i can get like 4.5% interest on saving if I decide to save till ERC comes down. Any ideas and calculators or methods to figure out whether it is worth paying ERC? 

Thank you.

In addition to the above comments, it is often advised to think about things in the round when considering how to use such a large amount. For example, what other expenditure you may plan to have in the short / medium / long term; what penson contributions you currently make and what pension you have already accrued; whether you have rainy day or emergency funds available.

I agree that Premium Bonds are a useful way to stash money, but I would not assume that you will  get 4.4% return. That is very much an average (it is not interest but essentially low risk gambling returns. I don't say that in a criticism - I have them too!)

Hoenir

Bristol_Lives said:

 I guess, i can get like 4.5% interest on saving if I decide to save till ERC comes down.

That will depend on your tax situation and how much you able to shelter that pays an after tax return greater than the cost of the mortgage. 

BikingBud

moneysaver1978 said:

In case you haven't seen this: https://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator/ - this might be what you were looking for?

Using the tool referred I get the following : 

Mortgage1 has changes, Mortgage2 should be similar to what you have

Overpaying 10% immediately and then 10% every Jan


With £22.3k being paid off you have in effect a ~ £200k mortgage with further steps down as you take off 10% lumps:



Overpaying 100k immediately:

Obviously the graph in effect shows a mortgage of £123k, if you delay the payment for a short while then the graph moves to the right and savings are reduced.
The excel doesn't allow the overpayment to be changed in steps but this can be worked out.

And after you pay off the mortgage, having booked the £168k savings, you can redistribute the payment for the remaining period of the mortgage so would also need to consider this:


So total around £427k in interest saved and interest earned.

For comparison, compound interest of £100k @5%:


Clearly there will be variations to interest rates, paid and charged and you will need to consider the impact of tax on your interest, with a potential exposure of over £4k from year 1 onwards dependent upon other factors.

Bristol_Lives

Thank you all, this was a great help! 

saajan_12

For decent advice we need more information:
- do you already max out pension / isa allowances each year, or how much room do you have left?
- what tax band are you, and how much other savings that earn interest?
- are you confident your other outgoings over the next 5 years will be covered by your income & emergency fund?
- what's your attitude to risk? (If nearing retirement or a time you may need to use the money, then generally people are more risk averse. If not and comfortable with risk then it might be better to maximise returns even if that means more risk).