Mortgage - Overpayments

[div0]

Looking at overpaying on our mortgage and lender (Nationwide) offers 3 choices:

1. Pay off my mortgage earlier by reducing my mortgage term
2. Reduce my future monthly payments
3. Keep my existing payment and term as-is. (At the next natural mortgage payment change, i.e. interest rate change, my payment will be automatically recalculated).

For what it's worth; we are at the start of a 5-year fixed deal.

Can anyone explain which option might be 'better' (and why)?

I have googled and there appears to be a lot of conflicting information, from people who appeared unsure of the advice they were giving.

I'm probably not going to explain this well - but my thoughts are:

• If you overpay by a fixed amount (n pounds) for the life of the mortgage, then 1 & 2 are effectively the same.
• If you stop overpaying at any point, then 1 would work out cheaper in the long run, but only because it results in higher 'standard' monthly payments.
• If you stop overpaying at any point and then 'overpay' 2 to match what 1 would have been - you get back to both being the same.

As far as I can tell 1 & 2 aren't much different, except that you get a bit more flexibility with 2. Ie, in future (if times were hard), you're not committed to slightly higher monthly payments - but if not then you can voluntarily make payments equivalent to 1, which result in the same overall payments and interest.

Now option 3 is where I'm not quite so sure - I would assume there is a subtle difference from option 2, but I'm not exactly sure what? Is there an implication that our 'fixed' payments get recalculated periodically (monthly/yearly) during the 5-year fixed deal? And that by choosing option 3, they remain truly fixed until the deal ends and we move onto a new rate?

Appreciate if anyone can explain the difference between the 3 options and what they would advise choosing.

At the moment I am leaning to option 3.

 

[Zethor]

#3 is the worst option because your extra money will sit in your account for a period of time without generating interest or, if it does generate it, it's an interest much lower than that of the loan. Do not choose this option, it's "free" money for your bank.

#1 is the best option in terms of costs for you. Higher 'standard' monthly payments reduce total nominal interest costs. Do this if you are certain you will never have issues with covering your current monthly payments.

#2 indeed offers more flexibility as your monthly income will feel less "pressure" from the loan. As you said, if you keep making overpayments, this option is the same as #1. In practice, it rarely happens. I would only choose this if there's a chance that your monthly wage will decrease at some point in the future.

 

[Kemik]

What's the interest rate on your mortgage?

If you can get a savings account that pays better than the mortgage costs then go with that (it is possible with some current mortgage rates).

You are better overpaying but don't change anything on the mortgage. This allows you to reduce payments without penalty if anything bad happens.

 

[Pipe & Slippers]

It all depends on your personal circumstances which is better for you

The following based on my Nationwide fixed rate mortgage....

With Nationwide, you can normally pay up to an extra £500 a month without triggering penalties. However, you can't vary your payments like a flexible mortgage because ther are some small-ish admin charges and some restrictions - I think it was £100 to go back to the ordinary repayment schedule after I'd been overpaying for some time

From what I understand, 1 and 2 are not effectively the same

With 1 you continue to make the same (inflated) monthly payments but the mortgage finishes earlier - the repayments stay static

With 2, any overpayment will reduce future monthly payments in an incremental way as the interest is calculated on a very slightly reducing capital amount

Note that with option 1, Nationwide will track your overpayments and create a 'reserve', so you can in the future take a repayment holiday. I don't think this happens with 2

Option 3 - I don't understand what you are being told. Your next interest rate change will be in 5 years time, assuming you have just taken the mortgage out, so I don't see any benefit to overpaying now if it's not going to be credited immediately to your account

Whatever, my choice has always been option 1. I like the idea of having a reserve to fall back on and the term shortening

BTW, if you do want to overpay by £500 a month, make it £499.99 or else the Nationwide send you a letter each month telling you you have overpaid....durrr

 

[div0]

#3 is the worst option because your extra money will sit in your account for a period of time without generating interest or, if it does generate it, it's an interest much lower than that of the loan. Do not choose this option, it's "free" money for your bank.

Can you explain this in any more detail?

I'm not sure I follow why the interest would be applied at a different rate?

As far as I know; all overpayments are applied within a day of being made. And this is true what ever option you pick.

Your interest is calculated daily, so your overpayment will still reduce your balance immediately and you'll start to be charged less interest, but your monthly payment won't reflect this straight away.

Are you suggesting that option 3 implies that this isn't the case and that the 'balance' is only recalculated periodically (yearly?) and so you continue to pay interest on a larger sum than you would otherwise need to?

I don't believe that this should be the case, but I could be wrong.

Or are you saying something else?

 

[Flying_Hellfish]

You could also take #2 if you plan on making other commitments later on, which would lower you available cash pot. For example, if someone was thinking of having children/another child during this peiod

 

[div0]

What's the interest rate on your mortgage?

If you can get a savings account that pays better than the mortgage costs then go with that (it is possible with some current mortgage rates).

You are better overpaying but don't change anything on the mortgage. This allows you to reduce payments without penalty if anything bad happens.

I have existing savings, which are not earning as much as my current mortgage rate. I realise I would be better off financially to drip feed these savings into overpayments, but intend to keep them as an easy access 'emergency' fund.

My monthly wage allows a reasonable amount of spare cash and because I cannot get a savings rate which would match, or beat the savings made by overpaying - I'm looking at pushing this into regular overpayments.

 

[Zethor]

You didn't say the balace is reduced immediately and I don't have access to their site.

If so then #3 is similar to #2, except your installment is reduced "at the next natural mortgage payment change".

 

[Street]

I'm with Nationwide and I over pay with option one. It means I finish my mortgage earlier and save a load on interest.. Seemed like the best option for me! By over paying a small amount each month, my mortgage finishes several years earlier and saves several thousand pounds.

With Nationwide, you can normally pay up to an extra £500 a month without triggering penalties. However, you can't vary your payments like a flexible mortgage because ther are some small-ish admin charges and some restrictions - I think it was £100 to go back to the ordinary repayment schedule after I'd been overpaying for some time

I've changed my overpayment quite often and never had to pay an admin fee for it!

 

[Burned_Alive]

Its not clear whether you're looking at a regular overpayment or a lump sum overpayment. Surely option 1 and 3 are basically the same?

Option 1; You're reducing your term through the overpayment. So this means you're reducing the borrowed capital and therefore the capital interest accrued over the term, but whats happening to your payments? Do they remain the same? Are you increasing your payment or making a lump sum overpayment? You haven't said.

Option 3; You're reducing your borrowed capital and therefore the capital interest accrued over the term. If you keep your payments as is, then you will pay your mortgage off earlier regardless of what the term on the deal is. Are they referring to keeping the term the same when you remortgage? This would mean your payments would reduce.

The best option would be what Option 3 alludes to, which is to pay off the capital, therefore reducing your interest over life of the mortgage, but keep your payments the same, which will mean you pay the mortgage off quicker. Assuming you're overpaying monthly this would also mean if you have a tight month, you dont need to make the overpayment so have spare cash.

 

[div0]

Its not clear whether you're looking at a regular overpayment or a lump sum overpayment. Surely option 1 and 3 are basically the same?

I'm looking at regular overpayments. I personally think 2 and 3 are closer, but it's starting to look like the difference in negligible.

Option 1; You're reducing your term through the overpayment. So this means you're reducing the borrowed capital and therefore the capital interest accrued over the term, but whats happening to your payments? Do they remain the same? Are you increasing your payment or making a lump sum overpayment? You haven't said.

I'm currently on a fixed rate deal, I was thinking of stretching this 'fixed' amount to what ever I feel I can regularly afford.

Option 3; You're reducing your borrowed capital and therefore the capital interest accrued over the term. If you keep your payments as is, then you will pay your mortgage off earlier regardless of what the term on the deal is. Are they referring to keeping the term the same when you remortgage? This would mean your payments would reduce.

It is unclear to me what they're referring to, hence the post

The best option would be what Option 3 alludes to, which is to pay off the capital, therefore reducing your interest over life of the mortgage, but keep your payments the same, which will mean you pay the mortgage off quicker. Assuming you're overpaying monthly this would also mean if you have a tight month, you dont need to make the overpayment so have spare cash.

This is what I am thinking too.

I wonder if option 3 alludes to something along these lines:

For an easy example; assume £150k for 25 years at 3%.

This works out at £711 / month (£213.395 total repayment)

Now let's assume we overpay by £289, so pay £1000 each month.

With option 1, the overpayment is immediately applied and the remaining balance reduced. At the end of the year, the remaining term is re-calculated based on an assumption that this reduced balance will be paid off at the standard rate (3%).

With option 2, the overpayment is immediately applied and the remaining balance reduced. At the end of the year, the monthly payments are re-calculated based on the reduced balance and remaining term.

• Without overpayments, at end of year 1 there would be and outstanding balance of £145,908. Year 2 at 3% of 145,908 for 24 years would be £711 (ie no change in 'standard' monthly payment).
• But with overpayments, at end of year 1, there is an outstanding balance of £142,383. Year 2 at 3% of £142,383 for 24 years would be £694 ('standard' re-calculated monthly repayment)

This means the 'standard' payments are reduced each month. But if the direct debit is a fixed amount (£1000), then you're just making a larger 'overpayment' to compensate (£1000-£694=£306, instead of £1000-£711=£289).

With option 3, it is the same as above, but the 'standard' monthly repayments are not recalculated at the end of each year, only at the end of the fixed term (ie when the rate changes). This means you're effectively paying £711 each year (and £289 overpayment).

So, if you're planning on making a continuous 'fixed' total payment each month - it doesn't matter which option you choose. All 3 options will pay off the mortgage within 13 years and with the same total cost (£179,496).

The only time it makes a difference, is if you plan on paying a set percentage above your 'standard' monthly costs. So if you're thinking, I can overpay by x%. So overpayment of ~40.% gives us our same £1000 monthly payment (£711 * 1.406 = £1000). However, with options 1 and 2 the remaining term or monthly rate get reduced at the end of the year (as per new balance) - so if you continue to overpay by a fixed percent, your overpayments are also reduced and it takes longer to pay off the full amount. Whereas option 3 doesn't recalculate the standard monthly repayments until the fixed term ends and so you continue paying a higher rate each month and pay off the full amount within the 13 years again.

In conclusion (for a fixed-rate mortgage at least):

• If you intend to set up a direct debit paying a fixed total amount each month (eg £1000), then it doesn't matter which option you choose.
• If you intend to set up a direct debit to pay your 'standard' monthly cost plus a fixed percentage overpayment (eg x + 40%), then option 3 is better.

At least, that is how I understand it But I could be wrong

 

[ivrytwr3]

Making overpayments as early as possible is the best way to go as you will be saving £££££'s on interest payments, thus paying off your mortgage much, much earlier.

My advice is always have a good few months salary 'for a rainy day' and throw everything else on mortgage overpayments - there are some at the end of the month who are paying penny jars, £1 coins etc, whatever money they have left they are throwing at the mortgage.

This may not work for you, but while i am still able to earn, i want my mortgage cleared as early as possible, have a look at the calc and see what works for you:

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

 

[Ste]

1 and 3 are the same on the proviso that all bets are off after five years. You're reducing the total balance. They are the right options.

2 is unfortunately the default and it's the default for a reason - it isn't actually an overpayment if subsequent payments are reduced, so the mortgage company don't lose any interest. This is why it's the default. This option is pointless as an overpayment - as if you want to make consistent overpayment you have to continually adjust the amount to counteract them reducing future payments. It is however useful if you want flexibility and think you might be short in future months. Good options for people on commission payments who are stretching things for example.

Option one is your best bet. Don't go over 15% of the outstanding balance in any one year or you will hit the ERCs. Otherwise you can be flexible on payments with no admin fees etc.

 

[div0]

Making overpayments as early as possible is the best way to go as you will be saving £££££'s on interest payments, thus paying off your mortgage much, much earlier.

My advice is always have a good few months salary 'for a rainy day' and throw everything else on mortgage overpayments - there are some at the end of the month who are paying penny jars, £1 coins etc, whatever money they have left they are throwing at the mortgage.

This may not work for you, but while i am still able to earn, i want my mortgage cleared as early as possible, have a look at the calc and see what works for you:
http://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator

I think most people would agree with your general sentiment - certainly that's what I am aiming to do.

My only real question related to the options given for how the overpayments are applied.

But if I have understood correctly, it actually makes little to no difference which I choose.

 

[div0]

1 and 3 are the same on the proviso that all bets are off after five years. You're reducing the total balance. They are the right options.

2 is unfortunately the default and it's the default for a reason - it isn't actually an overpayment if subsequent payments are reduced, so the mortgage company don't lose any interest. This is why it's the default. This option is pointless as an overpayment - as if you want to make consistent overpayment you have to continually adjust the amount to counteract them reducing future payments. It is however useful if you want flexibility and think you might be short in future months. Good options for people on commission payments who are stretching things for example.

Option one is your best bet. Don't go over 15% of the outstanding balance in any one year or you will hit the ERCs. Otherwise you can be flexible on payments with no admin fees etc.

So you agree with my thought process a few posts up?

For nationwide I think the max is 10% before ERC.

 

[Ste]

Yep. The short answer is to overpay and ensure that your regular payment amount doesn't go down. It doesn't matter how the bank dress it up - that's your aim. Otherwise it's not an overpayment it's just a shifting in the payment schedule. It will help with interest however as you clear the bulk of the balance sooner.

Ah 10% may well be right.

 

[div0]

Yep. The short answer is to overpay and ensure that your regular payment amount doesn't go down. It doesn't matter how the bank dress it up - that's your aim. Otherwise it's not an overpayment it's just a shifting in the payment schedule. It will help with interest however as you clear the bulk of the balance sooner.

Ah 10% may well be right.

Thanks.

The above was definitely my aim - was just struggling to figure out how the options might not have resulted in what I was hoping to achieve.

 

[The_Abyss]

Our mortgages are with Nationwide too, and we overpay by the same maximum (£500 pm IIRC). I assume we use option one. What this option also gives by default is the option to also use the banked overpayment for payment holidays in the future, should you need it in an emergency. Doing so will undo the good work you've done, but it doesn't cost you extra.

Overpaying for a while really starts to make a serious difference to the outstanding mortgage and the time to final repayment. It depends on your outlook but I find it just as satisfying as saving, if not more so.

 

[Ste]

Right decision! You'll need to call them in that case. I overpaid 10k in one hit and my monthly payments went down by 50 quid. Have now paid them but no way back - so have to set up an extra 50 DD every month

Once you have a set amount in some easily accessible savings overpaying the mortgage is usually the best option going as savings rates as so low and the mortgage term is so long. Per the above a very good feeling. I am currently making overpayments each month that take my 25 year mortgage down to 13 years - quite amazing how much interest is involved in a mortgage!

Good luck!

 

[cm1179]

Right decision! You'll need to call them in that case. I overpaid 10k in one hit and my monthly payments went down by 50 quid.

eh?