Overpaying Mortgage: Reduce Term or Reduce Payments

BennyC · 22 Nov 2011 at 07:36

I can't geat my ahead around whether to reduce my mortgage term or reduce my monthly payments.

As I understand it reducing the term will save me £ on not paying interest on however many years I reducee the term by. However would I be right to presume my monthly payment will go up?

Reducing my monthly payments is fairly straight forward but doesn't appear to save me any money in the long run.

For the record I have unlimited overpayment facility on my mortgage and am able to make roughly a 10-15% one of overpayment. I have a small mortgage so this sum, despite being 10%+ is only 4 figures, before the 'stick it in an ISA/Save it' suggestions come forward.

Thanks

BennyC

Minxy · 22 Nov 2011 at 07:42

Savings aren't great right now. If it was me I'd be over paying the mortgage by as much as possible.

DanH84 · 22 Nov 2011 at 07:46

depends on your financial position but I'd look to reduce term.

Haggisman · 22 Nov 2011 at 07:46

Why would the monthly payments go up? Bear in mind i'm not a mortgage adviser or anything, but surely the overpayment would just be the equivelant of several payments in one?

BennyC · 22 Nov 2011 at 07:53

Minxy said:
Savings aren't great right now. If it was me I'd be over paying the mortgage by as much as possible.

That's why I've decided to overpay a large chunk to save myself money (interest) in the long run. Though I'm not really in the position to afford the higher monthly payment from reducing the term.

If I were to make one large overpayment and then continually make a small contribution monthly would that not still save my money as the interest of each monthly payment will be calculated on the remaining capital balance which will be steadily reducing...

BennyC · 22 Nov 2011 at 07:55

Haggisman said:
Why would the monthly payments go up? Bear in mind i'm not a mortgage adviser or anything, but surely the overpayment would just be the equivelant of several payments in one?

I thought the same but from what I've read reducing the term means you're left with the balance to pay but in a shorter time frame which results in a higher monthly payment. I'm not sure if this is right or not...

DanH84 · 22 Nov 2011 at 07:57

If you've got an overpayment facility then any overpayments won't tie you in to a higher monthly payment, they'll just reduce your term and the total interest you pay.

LOAM · 22 Nov 2011 at 07:59

When you overpay, your overpayments pay off the capitol only (not interest). What tends to happen is an almost double effect. Your mortgage company will likely adjust your monthly payments in time to reflect the fact that your capitol amount has reduced (so you pay less interest) rather than reducing your term. This in turn allows you overpay more (if you keep paying the same amount then the ratio of overpayment : repayment increases ).

DanH84 · 22 Nov 2011 at 08:02

BennyC said:
I thought the same but from what I've read reducing the term means you're left with the balance to pay but in a shorter time frame which results in a higher monthly payment. I'm not sure if this is right or not...

You've read it wrong. That's for people who want to make set monthly payments and clear their mortgage in a shorter term, if you reduced your term without making this one of payment then yes, your payments would need to increase as you'd be paying the same amount of money off, over a shorter timeframe.

You aren't doing that though, you're reducing your debt from say 50k - 40k. This means their calculations about how long it will take you to pay off at your current monthly amount are now wrong. You'll be able to either lower your payments and keep the same term, or keep payments the same and reduce the term.

[TW]Fox · 22 Nov 2011 at 08:12

Minxy said:
Savings aren't great right now. If it was me I'd be over paying the mortgage by as much as possible.

If the interest on your mortgage is higher than the interest you'd receive after tax on an investment, then you are right - overpayment is the way forward.

BennyC · 22 Nov 2011 at 08:17

DanH84 said:
You've read it wrong. That's for people who want to make set monthly payments and clear their mortgage in a shorter term, if you reduced your term without making this one of payment then yes, your payments would need to increase as you'd be paying the same amount of money off, over a shorter timeframe.

That makes sense.

You aren't doing that though, you're reducing your debt from say 50k - 40k. This means their calculations about how long it will take you to pay off at your current monthly amount are now wrong.

As does that

You'll be able to either lower your payments and keep the same term, or keep payments the same and reduce the term.

The MSE overpayment calculator is confusing as it gives the impression that you can do both. If for example you say £50k @ 3% over 25 years with a £5k one off overpayment and a recurring £50 overpayment monthly. Would equal a saving of £9,240 in interest and reduce the term by almost 8 years.

http://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator

anything I don't mind · 22 Nov 2011 at 08:31

If you plan to sell it at some point i would pay as little as you can get away with. Especially if you are in negative equity. The less you can pay per month the better. If you plan to never sell it and live in the house for the length of the mortgage. Then paying as much as you can might be good idea.

In most cases it is unlikely that you would pay off the mortgage any time soon and paying more every month does not bring you that much closer to paying it off. I would always pay as little as possible. Because the money would be worth more to you in other way, holidays, new car etc. Than it would be tied up in a mortgage that is counting on house prices to increase.

My mom bought a house (in sa) for £25000 and put £10000 down, it is now worth over £50000, but she has paid in an additional £14000. If she sells the house she only owes the bank the initial mortgage payment plus interest. Which would be covered by the sale of the house. So in this instance i said that it would make sense to pay as little as possible in to the mortgage per month. Is that a good choice ? How would over paying in this situation benefit my mom?

DanH84 · 22 Nov 2011 at 08:37

BennyC said:
That makes sense.

As does that

The MSE overpayment calculator is confusing as it gives the impression that you can do both. If for example you say £50k @ 3% over 25 years with a £5k one off overpayment and a recurring £50 overpayment monthly. Would equal a saving of £9,240 in interest and reduce the term by almost 8 years.

http://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator

Yeah that makes sense because the terms set out in your mortgage plan are an illustration of what you will pay. In real terms the interest calculation is either done daily or monthly. As any overpayment comes directly off the capital outstanding even making fairly small overpayments early in the term can lead to large reducutions in outlay in the longer term.

BennyC · 22 Nov 2011 at 08:42

DanH84 said:
Yeah that makes sense because the terms set out in your mortgage plan are an illustration of what you will pay. In real terms the interest calculation is either done daily or monthly. As any overpayment comes directly off the capital outstanding even making fairly small overpayments early in the term can lead to large reducutions in outlay in the longer term.

I see, so using the overpayments to reduce future monthly payments > reduce capital > lower calculated interest > lower monthly payment.

The default with my lender for under £500 is to reduce the monthly payment however the option for payments over £500 was available and I wasn't sure if reducing the term would have been a better move.

For the record my mortgage stipulates an unlimited O/P'ment facility so the normal 5% charge on O/P'ments over £500 doesn't apply to me.

edscdk · 22 Nov 2011 at 08:47

Keep 5 to 10k in savings pay everything else of the mortgage

I don't a understand why you think monthly payments would go up.... Unless you reduce the term or elect to overpay monthly

anything I don't mind · 22 Nov 2011 at 08:52

I always thought that the interest amount was calculated on the initial amount and is always calculated on that amount, the only thing that changes is the rate. So paying off your mortgage sooner makes no difference to the interest amount as it is calculated on the initial loan. I also thought that all mortgages worked in this way and that when you pay off your mortgage, you firstly pay the interest on the initial loan back to the bank and only after that is paid do you start to pay off the loan itself.

NathanE · 22 Nov 2011 at 09:11

groen said:
I always thought that the interest amount was calculated on the initial amount and is always calculated on that amount, the only thing that changes is the rate. So paying off your mortgage sooner makes no difference to the interest amount as it is calculated on the initial loan. I also thought that all mortgages worked in this way and that when you pay off your mortgage, you firstly pay the interest on the initial loan back to the bank and only after that is paid do you start to pay off the loan itself.

No that's not how mortgages work.

If you have 100k of capital left to repay (and bare in mind, on a repayment mortgage this will be declining every month). Then your interest payment is quite simply the % of that 100k capital. So if you're on a 3% mortgage: 100,000 * 0.03 = 3000 / 12 = £250 per month. Then you add on the capital repayment to that, which obviously depends on the term. Say 25 years... 100,000 / 25 = 4000 / 12 = £333 per month. So total payment per month for this example would be £583.

It is that simple.

On the subject of overpayments. If you can find a savings account that is paying more in interest than you are losing on your mortgage. Then it would make sense to put your overpayments into that savings account instead. That way, not only can you get access to the money in the event of some unforeseen financial emergency. But you are also actually counteracting or "offsetting" some of your mortgage interest and actually turning what is effectively a profit on that money.

krooton · 22 Nov 2011 at 09:15

groen said:
I always thought that the interest amount was calculated on the initial amount and is always calculated on that amount, the only thing that changes is the rate. So paying off your mortgage sooner makes no difference to the interest amount as it is calculated on the initial loan. I also thought that all mortgages worked in this way and that when you pay off your mortgage, you firstly pay the interest on the initial loan back to the bank and only after that is paid do you start to pay off the loan itself.

lol

platypus · 22 Nov 2011 at 09:18

DanH84 said:
If you've got an overpayment facility then any overpayments won't tie you in to a higher monthly payment, they'll just reduce your term and the total interest you pay.

This is the case.

I would, (and we are doing) overpay as much as your bank will let you at present. We overpay into a cash ISA until its full each year, then overpay the actual mortgage.

krooton said:
lol

Would have expected better from you tbh krooton. Mortgages are a pretty complicated area.

Vonhelmet · 22 Nov 2011 at 09:29

Overpay and reduce the term. The amount you save long term can be staggering.