Term or monthly reduction?

MoneyRebel

I have looked over these posts and people are so gun-ho for reducing term because the maths makes it look logical.

But when you factor in life, reducing monthly make more sense:

1. Inflation - cost of living, all the small little life increases
2. Growing family - babies, I want this toy children, hungry teens - why do they cost so much
3. Can put the monthly reduction into an savings account and use it to make further over payments (this will simulate redusing the term)

So I am really interested in what people think and what people do. I currently take the reduction and pop it into savings it give me that flex to pay off mortgage or deal with life when it happens.

kimwp

If you need the money for life things, then why would you use it to pay off your mortgage instead of keeping your money free to use?

If you have the money spare, use it to reduce the term, to end up financially better overall. If you use it to reduce the monthly payments, you're pretty much just making your money unavailable for very little return.

BikingBud

Paying off lumps and reducing the term will always generate the best savings in interest.

There are bigger things at play, differences in interest rates for savings v mortgage and potential routes to produce more income from investing/saving than by paying off early. If you are considering overpaying you need to be sure what your desire is, freeing cash for other things or perhaps stopping/reducing work.

An often missed consideration is how much you need to generate pre-tax to pay the mortgage, and perhaps cutting out the £20k (maybe £33k before tax) mortgage payment per year will allow significant lifestyle changes as the drop out of higher rate tax bracket means you get much better value for your time.

I have paid £6k rather than £26k of interest by paying off early and bringing the term down to pay off when the current 1.19% deal finishes.

Newbie_John

There's really not much difference between reducing term and reducing monthly payments.

Seriously.

Imagine a case 11 years mortgage, £1000 monthly payment, 5% rate.

1.We overpay £10k in one go and reduce term by 16 months - calculators say we save £6744.

2.We overpay £10k in one go and reduce monthly, they drop from £1000 to £900 - calculators say we save £3021 in interests…

BUT.. its missing the key part of reduced monthly payments of £100.

In case 1. we will end up paying £1000 for 116 months = £116000 will be paid.

In case 2. we end up paying £900 for 132 months = £11900 will be paid.

There is £3000 difference, and if you put that £100 you saved monthly to a 5% saving account it would generate £3000 in interests.

You can acheive the same by putting all money into 5% saving account (ISA to keep it tax free).

But if you think you may need money, then there is no point for overpayment in first place. Just save instead.

BikingBud

So you save more than twice as much:

1.We overpay £10k in one go and reduce term by 16 months - calculators say we save £6744.

2.We overpay £10k in one go and reduce monthly, they drop from £1000 to £900 - calculators say we save £3021 in interests…

But that is not significant? Hence my first paragraph the best savings in interest

Yes there are other routes hence my second paragraph, and my point about deciding what is best for you.

For me paying off at the end of the current deal and stopping work is best. Why earn to generate £20k after tax and pay 40% tax, that's 40% of my time I'm giving up, when I don't need to?

Newbie_John

https://forums.moneysavingexpert.com/discussion/comment/82171474#Comment_82171474

No it's not better - its the same. If you put that £100 saved a month to a saving account with rate higher than yourr mortgage than you save more than reducing term. If you spend it on ice creams than its worse. But the difference only comes from - how much you actually overpay each month - and by reducing monthly payments - you end up overpaying less each month.

If you save that £100 extra each month you can still pay off your mortgage 1.5 years quicker in full.. - making them equal financially.

BikingBud

I feel you are deliberately missing my point, you said it is better to pay off and keep the term the same. That is the mortgage interest saved. Its in the bank, debt reduced significantly. Jobbed!

Some do not have the discipline to save that £100 per month and for some the figure might also generate tax on the interest.

I acknowledged there are other considerations and that personal circumstances and intent was key but you skipped over that acknowledgment. Why?

What are your thoughts about continuing to work and potentially unnecessarily losing 40% of your income?

Having saved 20k and paid off my mortgage 5 years early and now not having to produce 33k in income before tax. I am very happy with where I am thanks.

Wealth and prosperity are not just about finances!

Newbie_John

Theres a lot of ways to avoid paying tax of you 40%+ earner - for example low coupon gilts - with guaranteed 5%+ return tax free.

Anyway, my point here is - these two types of mortgage are the same, and I stick to that.

They are as different as overpaying £500 and overpaying £600 with reduced term - which one is better? All depends what you can afford.