Overpayments - do they reduce mortgage term?

ian1246

Thing to remember and which is all too often overlooked is inflation. 2% inflation over 20 years  means £100 now will be worth £148 then.

Generally, bar interest rate fluctuations, your monthly mortgage amount will remain fixed.

A £1000 mortgage now therefore will only be worth in real-terms equivilant to £667 in 20 years time, assuming an average 2% inflation.

If your overpaying the mortgage to reduce the term, your only going to realise that benefit when your mortage is finally paid off in many years time - by which point inflation will have eaten a significant chunk of the value of the actual financial benefits from your overpayments (i.e. £100,000 "saved" interest will be actually in real value £66,700 interest in 20 years time, assuming 2% yearly inflation)

On the flip-side, if you overpay to reduce your monthly mortgage, that "saved" monthly payment you benefit from immediately - meaning if we're talking about a 20 year mortgage, you'll have benefitted from that saving for 20 years vs. Reducing the term - with the benefit in real-terms significantly higher due to the impact of inflation (i.e. savings in year 1 will in real-terms be worth far more than the same £££ savings in year 20, as an example).

On top of that, it gives you the option to try and offset the impact of inflation on those monthly savings - i.e. if by overpaying £3000 your monthly mortgage drops by £15.00, if inflation is 2%, you could put that extra £15 a month info a saving account paying 4% interest and compound it, or put it into a stocks & shares isa for longer term growth, or even a pension.

Just an alternative way of looking at it.

BikingBud

ian1246 said:

Thing to remember and which is all too often overlooked is inflation. 2% inflation over 20 years  means £100 now will be worth £148 then.

Generally, bar interest rate fluctuations, your monthly mortgage amount will remain fixed.

I think you have that the wrong way round. Inflation will reduce the future value of your cash. Something that costs £100 now will, dependent upon the inflation figure, most likely cost more. Growth will increase the value! Hopefully ahead of inflation.

A £1000 mortgage now therefore will only be worth in real-terms equivilant to £667 in 20 years time, assuming an average 2% inflation.

That's the correct way round but typically it is acknowledged that your income will rise with or around inflation hence the cost to service the mortgage will become a smaller and smaller portion of your income.

If your overpaying the mortgage to reduce the term, your only going to realise that benefit when your mortage is finally paid off in many years time - by which point inflation will have eaten a significant chunk of the value of the actual financial benefits from your overpayments (i.e. £100,000 "saved" interest will be actually in real value £66,700 interest in 20 years time, assuming 2% yearly inflation)

On the flip-side, if you overpay to reduce your monthly mortgage, that "saved" monthly payment you benefit from immediately - meaning if we're talking about a 20 year mortgage, you'll have benefitted from that saving for 20 years vs. Reducing the term - with the benefit in real-terms significantly higher due to the impact of inflation (i.e. savings in year 1 will in real-terms be worth far more than the same £££ savings in year 20, as an example).

On top of that, it gives you the option to try and offset the impact of inflation on those monthly savings - i.e. if by overpaying £3000 your monthly mortgage drops by £15.00, if inflation is 2%, you could put that extra £15 a month info a saving account paying 4% interest and compound it, or put it into a stocks & shares isa for longer term growth, or even a pension.

Just an alternative way of looking at it.

Why is it many years time? A 10 year mortgage paid off in 5 is a substantial cash saving. As is a thirty year mortgage paid off in 20.

Looking purely at a mortgage, excluding other things to do with your cash, the most significant savings are achieved by reducing the term. Compounding works on the way down the same way it works on the way up. Big chunks early benefit YOU. I wonder how many people that sat on recurring 2year deals @2% now wish they had chunked of large portions of their capital and sought to reduce the term. Mortgage lenders reducing your payments, (recalculating) to retain longer payment profile is a route to minimise their losses from over payment. 

A better LTV gives you a double win, lower amount borrowed and better interest rate. The issue is that most people are chasing house prices up and unless you have a large pot of equity this then leads to a longer product term, going out to 30>35 years appears to be the new norm and lenders love it for one reason.

Lots more interest:


And that's without any overpayments. Look at the cost v benefit of the first five years ~£111k paid but capital only reduced by ~£45k.

Another route is take the £300 per month difference and if you can get a consistent 4% for 25 years you might have ~£145k cash at the same point you would have about £155k left on the mortgage. If you get 6% then you might have ~£193k but in the similar manner you will also get mortgage rate fluctuations that mean you have achieved less equity. You only know what you are getting now, anyone who thinks they know what might occur is guessing, they might consider it an educated guess, they are still guessing.

Some rather than paying off the mortgage pay into a pension pot to build a massive fund that seems to be attracting more envy from some. That envy has already manifested as a pension pot raid via IHT. Whilst pensions are great are they everything?

It's about balance but what does seem to be occurring especially with Halifax is that they inhibit the customer's choice by introducing barriers, must see an advisor!

Whose advisor? Theirs, not yours, not independent!

Ask why?

What do they want to discuss?

Ask "Do you believe I am risk of not paying off the mortgage if I reduce the term?" Why the payments are the same as were approved by you! 

Or might it be to tell you "how silly you are wanting to reduce the term, think how restrictive that might be!"

I am sure it is in the Ts&Cs of their newer products but it is not something many consider when setting out to get a mortgage where the primary concern is how much can I get and what is the interest rate, (perhaps the same perspective that lead to many believing they had been scammed by car finance deals).

It's all very short term thinking whereas a better perspective might be ensuring you understand how to pay it off as early and as cheaply as possible and work that as part of a longer term plan, that you own and control.

Freedom by paying a mortgage off early and not having to work, not having to cover PAYE which is a 20% offset that few consider.

Bear in mind the true measure of wealth is time!

Just an alternative way of looking at it  

HalfMoonBoy

Very useful information. My aim was to try to reduce the mortgage balance/time (in my mind they are equivalent) as much as possible to 1) save on interest (currently our mortgage is 4.17% 5 year fixed started in December 2024), 2) improve LTV as much as possible to re-mortgage in 4 years and 9 months at better (hopefully) conditions.

I currently have two jobs to overpay an amount equivalent to the mortgage rate, something I am aware it's unlikely I will be able to do for 30 years. My plan was to push as much as possible now, save on future interest, shorten the mortgage, have a better deal at re-mortgaging, and then be in a stronger position with expenses that - inevitably - will come with children becoming adolescents.

I am totally aware it sounds like an extreme plan, but there are a number of additional (private) considerations that have an influence on why we did this choice.

It seems the best way forward then is to book a 2-hour meeting with the Halifax Mortgage Advisor and stress that we would like our overpayments to reduce the mortgage term (I imagine the sooner the better).

Hoenir

HalfMoonBoy said:

It seems the best way forward then is to book a 2-hour meeting with the Halifax Mortgage Advisor and stress that we would like our overpayments to reduce the mortgage term (I imagine the sooner the better).

Lenders operate under a duty of care these days as part of their regulatory duties. This is to ensure that borrowers are aware of the implications of what they are doing. Also the lender does not expose themselves to any claim of misdoing. As I've said earlier reversing the decision and extending the agreed contractual term is not a push of a button. May well incur an additional fee. The likelihood of the term reduction being declined is small.