overpaying query

learningmore

Hi everyone - I have a question that I'm hoping some people may be able to provide answers for.  It sounds a simple one, but I'm not sure it is as simple as it sounds!

1. Does it have more of an impact overpaying a mortgage when interest rates are high or when interest rates are low?    I can't get my head around this as does it depend on the amount outstanding, what are the factors involved here?   I have been overpaying mine for maybe 3 years now, but I honestly don't understand whether it has more of an impact when rates are say 1% compared to 5%.      Logic would dictate that at higher rates I would be negating the impact of the higher interest rate rather than chipping away at the capital, so does this mean that there is no point overpaying when interest rates are high?    

Thanks in advance to anyone that feels they may be able to help here.
I have a very long way to go but I have come to realise the benefits of overpaying, despite making sacrifices to do so.

LadyWithAPlan

Each month you make an OP it will go against your principal - so when the mortgage company calculates at the beginning of the month how much interest to charge it does so on the decreased balance -  hence you save more money if it’s a higher rate 

there is a great mortgage op calculator on here where you can plug in your ops and see the difference - maybe someone can link it or I will try to find it later 

people also track the daily interest they pay and watch that go down 

learningmore

Forgive my naivety on terminology, but what do you mean by 'principal' in this context?

I'm still not sure I follow what you mean - would it not have more of an impact on a lower interest rate rather than a higher, as you are then overpaying more capital rather than interest?

Surely if it's a higher rate then the overpayment is simply wiping out more in the way of interest rather than helping to reduce the capital over time?

I'm not sure it's as simple as that though as I imagine the size of the remaining debt plays a part too.

Are you able to simplify this at all (or can anyone) any further?

South_coast

Principal = capital

The interest is taken care of within your monthly payment, whether it's a higher rate or a lower rate (that's why your payment amount fluctuates). 

Additional payments reduce the principal/capital owing, so will reduce the balance and therefore less interest will be payable, as it is due on the balance outstanding. So overpaying on a higher rate will have more impact on reducing the monthly interest payments (as the balance owing will reduce), but overpaying on a lower rate will have more impact on reducing the balance (as you'll be paying less in interest anyway, so likely will have more available for overpaying)

kempiejon

My monthly mortgage is about 30 quid more than the contracted amount. I occasionally bung a larger one off overpayment too. Annoyingly when I make a one off overpayment, despite asking for my monthly payment to remain unchanged and the term to be reduced 3 out of 4 times the monthly amount has reduced.

Each time I have had to reset the payment to my preferred amount - which as I said is slightly overpaying each month.
I like the idea of being mortgage free but I think we'll reset to a higher amount in the next few years as SO wants a bigger property in a prettier more rural area. 

learningmore

South_coast said:

Principal = capital

The interest is taken care of within your monthly payment, whether it's a higher rate or a lower rate (that's why your payment amount fluctuates). 

Additional payments reduce the principal/capital owing, so will reduce the balance and therefore less interest will be payable, as it is due on the balance outstanding. So overpaying on a higher rate will have more impact on reducing the monthly interest payments (as the balance owing will reduce), but overpaying on a lower rate will have more impact on reducing the balance (as you'll be paying less in interest anyway, so likely will have more available for overpaying)

This does make some sense, but it doesn't answer the question as to which is more effective.

Overpaying at present with such high rates feels like I'm chipping a lot less at the capital/remaining balance relative to when I overpaid the exact same amount when interest rates were so much lower.

Not quite sure what the answer is here - obviously if rates remained unchanged then I would be saving more in interest over the long term (is that right?)   but taking longer to pay off the debit?

It still seems a grey area of sorts.

saajan_12

Basic question: are you within a fixed rate / minimum term mortgage, or on the SVR rate? 

learningmore said:
Logic would dictate that at higher rates I would be negating the impact of the higher interest rate rather than chipping away at the capital, so does this mean that there is no point overpaying when interest rates are high?    

1. Say you have £100k outstanding on the mortgage with a 3% interest rate on YOUR mortgage (note may be different to what the 'market' rates are). Say your monthly payments are £750. 
2. Each month, they calculate the interest based on your balance - so 3% x 100k / 12 = £250. 
3. From your monthly payment, that £250 goes to interest, and then the rest (750-250 = £500) goes to capital. 
4. If you make a 2k overpayment, then that goes straight to capital as the interest is already paid for that month. 
5. The next month, the interest will be recalculated based on the remaining balance, ie 100k - 500 - 2000 = 97,500. So interest is 3% x 97,500 /12 = £244. 
6. Then from your monthly payment, £244 goes to interest so the remaining £506 goes to capital, leaving a balance of £96,994. 
7. So far you've paid off an extra £2006 on the capital compared to without the overpayment. Each month, you save ~£6 in interest, ie £72 over the year. In fact its a little more as that interest compounds, so roughly £93 over a year. 
8. The next year, whatever happens to your interest rate (assuming you have a variable mortgage), you're starting with £2093 less so you'll pay that much less interest. If interest rates rise it makes an even bigger difference, but if they decrease or stay the same, there's still *some benefit.  

Basically as long as you weren't vehind already, the overpayment DOES reduce the capital. If they keep the monthly repayments the same and reduce the term, you'll continue to get a compounding effect on that amount you've paid off, regardless of whether you 

The only reason not to overpay would be if you have a fixed rate mortgage with a low interest rate and you can earn more interest with the money in a savings account after tax and if you can trust yourself not to spend it. 

learningmore

Thanks for this example.

The only part I don't follow is point number 8 - I can't see where the figure £2093 comes from after a year of overpaying.   I understand the £72 saving in interest over the year, but not sure where the 2000 comes from over the year - I thought that was the capital reduction after a few months as per your example.