Overpaying Mortgage: Reduce Term or Reduce Payments

But my sister has an interest only mortgage where she says that she is just paying off the interest at the moment.

But all this over paying is counting on that house prices will increase, if you bought a house for £200 000 and have been over paying and then house price drops to £150 000 but you have been overpaying you could lose more money than if you paid as little as possible.

If you listen to the guy who wrote the book rich dad poor dad, i think he would recommend paying as little as possible because he is all about the cashflow, but i could be wrong.
 
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groen said:
But my sister has an interest only mortgage where she says that she is just paying off the interest at the moment.

But all this over paying is counting on that house prices will increase, if you bought a house for £200 000 and have been over paying and then house price drops to £150 000 but you have been overpaying you could lose more money than if you paid as little as possible.

If you listen to the guy who wrote the book rich dad poor dad, i think he would recommend paying as little as possible because he is all about the cashflow, but i could be wrong.
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The longer you take to pay off the capital, the more you will waste paying the interest, just like paying the minimum amounts on a loan or credit card.
 
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.
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To quote red dwarf: like german tourists, the stupid are everywhere...
 
groen said:
But all this over paying is counting on that house prices will increase, if you bought a house for £200 000 and have been over paying and then house price drops to £150 000 but you have been overpaying you could lose more money than if you paid as little as possible.
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If you bought it at 200K then regardless of what the market does you still owe the lender the amount you borrowed. They wont write it off because the market value has dipped, you will just be in negative equity IE you still lose part of your investment. The only difference is you probably owe all of it still because you have only been paying the interest.

You are just deferring the capital repayment. When ever you buy a house at Value X and the market dips leaving it at a lower value Y, you lose some of your investment (if you then sell at value Y).
 
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LOAM said:
If you bought it at 200K then regardless of what the market does you still owe the lender the amount you borrowed. They wont write it off because the market value has dipped, you will just be in negative equity IE you still lose part of your investment. The only difference is you probably owe all of it still because you have only been paying the interest.
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That is exactly my point. So overpaying you could be effectively wasting more money, because if you are pay say £500 a month instead of £1000 a month then over five years you are paying twice as much in to your mortgage. If you go into negative equity then at least you can cut your loses and sell at a loss but you a tleast have not been overpaying the monthly payments.

On the other side if the house prices are increasing then you can pay as little as you can get away with and sell the house for twice as much as the mortgage and then use that money to pay the bank back and then you still would have not paid as much in because you were not over paying.

So the way i see it is the only reason to over pay would be if you plan to never sell the house and if you count on house prices to never fall below the level of the initial mortgage amount.
 
LOAM said:
If you bought it at 200K then regardless of what the market does you still owe the lender the amount you borrowed. They wont write it off because the market value has dipped, you will just be in negative equity IE you still lose part of your investment. The only difference is you probably owe all of it still because you have only been paying the interest.

You are just deferring the capital repayment. When ever you buy a house at Value X and the market dips leaving it at a lower value Y, you lose some of your investment (if you then sell at value Y).
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Thats pretty much exactly what he said :p.

groen said:
On the other side if the house prices are increasing then you can pay as little as you can get away with and sell the house for twice as much as the mortgage and then use that money to pay the bank back and then you still would have not paid as much in because you were not over paying.
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Unfortunately this unsustainable myth of ever increasing house prices are what led to the crash in the first place.

So the way i see it is the only reason to over pay would be if you plan to never sell the house and if you count on house prices to never fall below the level of the initial mortgage amount.
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Or, the reason we over pay is so that we can get as much equity as possible (again, assuming house prices won't fall too much, but this is a safe bet in Cambridge), so that we we come to rent out the house, we can get more favourable terms on a BTL if we choose to get one of those.
 
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groen said:
But my sister has an interest only mortgage where she says that she is just paying off the interest at the moment.

But all this over paying is counting on that house prices will increase, if you bought a house for £200 000 and have been over paying and then house price drops to £150 000 but you have been overpaying you could lose more money than if you paid as little as possible.

If you listen to the guy who wrote the book rich dad poor dad, i think he would recommend paying as little as possible because he is all about the cashflow, but i could be wrong.
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An interest only mortgage (and assuming you don't make unforced capital repayments) means that your remaining capital will be the same for each month. So you'll always be paying the same amount each month. On a £100,000 mortgage, assuming a 4% interest rate, that'll be £333/month.

Whilst interest only mortgages were useful a few years ago. They aren't so useful any more, at least not to people like your sister that seemingly aren't putting in place the cash they will need in 15-20 years to pay off the loan.

The big thing that has changed is... house prices are no longer constantly going up. They have fallen back around 15-30% (depending on area) and are now remaining stagnant at those new levels, more or less.

Now consider if you had a interest only mortgage on one of these properties whose value has fallen 30%. Say your property was worth £100,000 and you had an interest only mortgage on it of £95,000. Now say the new property value will be £70,000. 100,000 - 70,000 = £30,000 of negative equity. So in order to move home you will need to find £30k just to pay off the £95,000 that is left on your mortgage debt.

Yes in the above example, if you had been on a repayment mortgage you would have lost money. But at the same time the mortgage debt would have been at a lower level than £95k. It depends how many years went by making capital repayments before you wanted to move home, of course. But it isn't really "lost" money. It was lost because you would have made a bad gamble on an asset that has depreciated in value. That's all. People that buy cars know all about depreciation. It is an interesting part of social economics as to why people don't seem to attribute the same logic (at least, the risk of it) to property.
 
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krooton said:
The longer you take to pay off the capital, the more you will waste paying the interest, just like paying the minimum amounts on a loan or credit card.
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A mortgage is considerably different than a credit card and even a loan. This is because mortgages are seen to many people as an investment. People do not look at a credit card or a loan as an investment. The investment idea is rooted in the idea that house prices will continue to rise for infinity. I see the point you are trying to make though about interest. But with 25 year terms i am surprised why people even bother to try and pay it off.
 
NathanE said:
Yes in the above example, if you had been on a repayment mortgage you would have lost money. But at the same time the mortgage debt would have been at a lower level than £95k. It depends how many years went by making capital repayments before you wanted to move home, of course. But it isn't really "lost" money. It was lost because you would have made a bad gamble on an asset that has depreciated in value. That's all. People that buy cars know all about depreciation. It is an interesting part of social economics as to why people don't seem to attribute the same logic to property.
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Probably because demand outstrips supply in no way like cars, certainly in cities and populas areas.

For the record, I don't think interest only mortgages should be legal.
 
groen said:
That is exactly my point. So overpaying you could be effectively wasting more money, because if you are pay say £500 a month instead of £1000 a month then over five years you are paying twice as much in to your mortgage. If you go into negative equity then at least you can cut your loses and sell at a loss but you a tleast have not been overpaying the monthly payments.

On the other side if the house prices are increasing then you can pay as little as you can get away with and sell the house for twice as much as the mortgage and then use that money to pay the bank back and then you still would have not paid as much in because you were not over paying.

So the way i see it is the only reason to over pay would be if you plan to never sell the house and if you count on house prices to never fall below the level of the initial mortgage amount.
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Really...? If you have paid twice as much on your mortgage, you will have less mortgage to repay from gross sale proceeds. Your net proceeds would be the same, subject to possible incidental interest differences. Your argument only works if you can effectively cut your losses and run (like in the US), which you cannot here.
 
NathanE said:
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.
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Except it isn't that simple and that is wrong?

I'm pretty sure mortgages are repaid using the Rule of 78 principle, which even though Groen was incorrect in saying that the capital is not repaid until all the interest is paid off, it's actually a closer representation than your even spread of interest calculation.

In a loan with interest calculated per the Rule of 78s, the total interest over the life of the loan is calculated as either simple or compound interest and amounts to the same as either of the above methods. Payments remain constant over the life of the loan; however, payments are allocated to interest in progressively smaller amounts. In a one-year loan, in the first month, 12/78 of all interest owed over the life of the loan is due; in the second month, 11/78; progressing to the twelfth month where only 1/78 of all interest is due. The practical effect of the Rule of 78s is to make early pay-offs of term loans more expensive. For a one year loan, approximately 3/4 of all interest due is collected by the sixth month, and pay-off of the principal then will cause the effective interest rate to be much higher than the APY used to calculate the payments
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So infact with mortgages the first few years of payments are mostly just interest with little repayment off the capital.
 
groen said:
A mortgage is considerably different than a credit card and even a loan. This is because mortgages are seen to many people as an investment. People do not look at a credit card or a loan as an investment. The investment idea is rooted in the idea that house prices will continue to rise for infinity. I see the point you are trying to make though about interest. But with 25 year terms i am surprised why people even bother to try and pay it off.
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Generally speaking... people with repayment mortgages view their home as an asset, and one that they think and hope will appreciate in value.

People with interest only mortgages fall into three categories:

1. Those who are almost certain that their property value will increase and they then sell the property at higher value, resulting in positive equity and a nice wedge of cash.

2. Those who are happy to manage their own finances. They don't "need a bank telling them how or when to make capital repayments". These people tend to have savings accounts or other financial investments that they are very sure will be at least as good or preferably far better than a repayment mortgage.

3. Those who see the cheap monthly cost of living and decide "it's cheaper than renting". But don't make any deposits into savings accounts. Don't have any plan for where they will live in 15 years when the interest only mortgage deal ends. And aren't afraid of (but definitely should be) the cookie monster that is "negative equity".
 
Freakbro said:
Except it isn't that simple and that is wrong?

I'm pretty sure mortgages are repaid using the Rule of 78 principle, which even though Groen was incorrect in saying that the capital is not repaid until all the interest is paid off, it's actually a closer representation than your even spread of interest calculation.



So infact with mortgages the first few years of payments are mostly just interest with little repayment off the capital.
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Now find proof that any UK consumer mortgage uses the archaic Rule of 78.

This is something that companies like Ocean Finance were infamous for in the 90s and 00s. The practice has been banned.

Department of Trade and Industry said:
However, changes to the Consumer Credit Act mean that, on Tuesday, the Rule of 78 will be abolished on all new loans. Providers will now only be able to charge a maximum of two months' interest - as opposed to sums that have sometimes been much higher.
The reform will apply immediately for new borrowers. Existing ones who have loans for terms of 10 years or less, and want to settle early, will not benefit until 2007. Those with loans for longer than 10 years will not be covered until 2010.
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Nowadays, mortgages have what is called an early redemption charge. Which is often a percentage between 1 to 3%. It really depends on your mortgage product. Some don't have any early redemption charges.


Further reading: http://forums.moneysavingexpert.com/showthread.php?t=1101237
 
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this is a real catch 22 for me. i could, if i drew a lot of my savings etc out, bite two 10% (most i can overpay P/A without a charge) overpayments over 2 yrs out of my mortgage sum. this would obviously reduce my repayments but my repayments are sustainable. i was always of the school of thought that if ones repayments are sustainable, why use your savings to reduce the term? the advantages are obvious, i know but it comes down to having a life aswell. if i use the majority of my savings to knock a total of 20% off my mortgage sum (as great as that would be) i then have minimal savings left, that's any problems i should come across in life, financially, leaving me in a real pickle! same with should i want a nice holiday, vehicle upgrade or repair etc.
 
Exactly. Sure if you run in to some money and you are earning £25k a month or something similar and you have a £300k left on your mortgage and you can reduce your payment term from 25 years down to 5 years. Then i would say go a head. But if we are talking about paying in £500 mortgage or a £800 a month by reducing interest by £10000 and your terms from 25 to 23, then id say just stick to £500 and put the money in to living well and buying a new car or a holiday for the family, better education for your children. I think that depends on personal circumstances and how much spare money you have.
 
NathanE said:
Now find proof that any UK consumer mortgage uses the archaic Rule of 78.
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My annual Mortgage statement :p


I'm glad to hear that the practice has now been banned since 2005 (it was banned in the US from 1992) but I seem to fall under the definition of not having been covered until 2010.

I will look at my next annual statement to see what changes have occured.
 
The reason to overpay or pay off the mortgage using the repayment model is to end up at 60'ish, my age, with it paid off and then live rent / mortgage free in your own property. The banks can then foxtrot oscar in my view.
 
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