Key Post "Overpaying my mortgage - should I reduce the term or the monthly repayment?"

[Brendan Burgess]

This question comes up in a variety of ways and the threads often go off topic with irrelevant calculations.

The interest charged each year is exactly the same - we will return to this.

Reducing the repayment is simply reducing the payment you are contractually obliged to make under your mortgage contract.

But this does not stop you from paying more. Under Irish law, a variable rate borrower can pay back some or all of their mortgage at any time without penalty.

However, as most mortgages now are fixed rates

Case study
Let's say you have a mortgage of €100,000 with 20 years left at 3%. The repayment is €554.

You pay off a lump-sum of €20,000 - the lender gives you a choice
Reduce the repayment to €443 and keep the 20 year term
or
Keep the repayment at €554 and reduce the term to 15 years.

Keep the term at 20 years and reduce the contractual repayment to €443

But you can continue to pay €554 or more as you wish.

If, at some future stage, you get into financial difficulty and want to reduce your repayment to €443, you can do so without asking the bank's permission and without affecting your ICB record

If you have reduced the term to 15 years and kept the payment at €554, if you then reduce the repayment, you will be in arrears.

 

[Brendan Burgess]

Update January 2022

You may wish to choose a shorter term if you want to overpay your mortgage

The initial Key Post was written when we had a normal mortgage market and variable rates were by far the most popular.

As of 2022, we have a bizarre market where fixed rates are much lower than variable rates and so the right thing to do is to fix your mortgage rate.

If you overpay a fixed rate mortgage, you may face an early repayment penalty.

Some lenders allow you to overpay 10% of the balance free of any penalty.
But if you want to pay more, you may face a penalty.

This makes the decision whether to cut the term or the monthly repayment a bit more difficult.

The advantage of cutting the repayment is that you have a lower committed repayment.
But you are comfortable that you intend to pay this amount in full and clear your mortgage quicker than originally planned, then cut the term and not the repayment.

 

[Brendan Burgess]

In practice, how do I overpay my mortgage each month?

Different lenders have different systems.

Some lenders will allow you to simply transfer money to your mortgage account by bank transfer.

Apparently, the bank must write to you to acknowledge receipt of the money.

If your bank finds this confusing, it may be simpler just to save up the money in a deposit account and make one off capital repayments from time to time.

 

[Brendan Burgess]

Some of the confusing and misleading arguments which distract people

"You are always better to shorten the term. By paying €554 per month instead of €443, you will pay off your mortgage 5 years earlier and save yourself €20,000 interest".

That is a separate argument. You can still keep paying €554 per month, but just tell the bank that you are keeping the term the same. So there is no difference in the interest charged.

"Overpaying my mortgage by €100 a month is just not worth it as it will only reduce the interest by buttons"

You should look at the calculation only on an annual basis.
If you pay €1,000 off your mortgage at 3.5%, you will save €35 in interest.
If you pay €10,000 off your mortgage, you will save €350.

Don't forget that at 3.5%, the interest on €100,000 is only €3,500 a year.

Repaying an additional €100 won't make much of a difference,but paying €100 a month will.

The interest of 3.5% is the equivalent of getting a tax-free and risk-free return of 3.5% on an investment. It is better to pay down your mortgage than to put it on a taxable deposit which pays 0.5%.

And, your overpayments may well result in reducing the Loan to Value into a different LTV band which might get you a lower mortgage rate on the entire mortgage.

 

[Brendan Burgess]

Frequently Asked Questions

I have a fixed rate mortgage - can I pay a capital sum off it without penalty?

Each bank has its own policy on this.

I understand that BoI allows you to repay up to 10% of the mortgage each year without penalty.

Ulster Bank allows you to overpay up to 10% of the mortgage balance each year without penalty. That is a lot. The typical capital and interest repayments on a 20 year mortgage amount to about 6% of the balance. So you can double your mortgage payments without penalty or pay off fairly significant lump sum.

Even still, it might be worth checking what the early repayment penalty is. It might be a lot smaller than you think, and it could be zero.


If I need the money in 5 years, can I get the overpayments back?
Not usually.

However, I understand that ptsb treats overpayments as credits i.e. the opposite of arrears. While you can't get it back, you can stop paying your mortgage until you have used up the credits.

So if you might be replacing your car in the next year or two, you might be better off not overpaying your mortgage.

If I reduce the term, can I change my mind later and reduce the repayment?

You can ask, but you do not have a right to a reduced repayment. It's quite likely that the lender will ask you for a Standard Financial Statement and mark your mortgage as "rescheduled" which will affect your ability to get a new mortgage from another lender.

So as it's such a good investment, should I really scrimp and save to pay down my mortgage as quickly as possible?

No. You should get a balance in your financial affairs. Unless you have a very large mortgage or unless you are in deep negative equity, there is no rush to be mortgage-free.

Increasing your contribution to your pension fund may be better value than paying down your mortgage.



Should I overpay my mortgage or my Credit Union loan?
You always pay off whichever is the dearest. If you have normal mortgage, it means that you should pay off your credit union loan first.

(If you have a buy to let loan on which you are getting tax relief, then you need to do a calculation - but the principle is the same - pay off the loan with the highest interest rate after tax.)

 

[ANCHOR MAN]

Does it make any difference what the interest rate is when you make a lump sum repayment or is that irrelevant?

 

[Brendan Burgess]

Good question. What do you have in mind?

If you are on a cheap tracker, you probably should not be overpaying your mortgage.
If you have a normal rate mortgage and other debt, you should repay the other, more expensive debt first.

But if you are overpaying your mortgage, the rate makes no difference to the decision whether to shorten the term or reduce the repayment.

Brendan

 

[ANCHOR MAN]

Good question. What do you have in mind?

If you are on a cheap tracker, you probably should not be overpaying your mortgage.
If you have a normal rate mortgage and other debt, you should repay the other, more expensive debt first.

But if you are overpaying your mortgage, the rate makes no difference to the decision whether to shorten the term or reduce the repayment.

Brendan

I was thinking would it make any difference to pay a lump sum while the rate is 3.3% or would it be better to make it if the rate was 4% for example, with no other loans or debt to pay back. But it surely makes no difference, just wanted to double check. Thanks Brendan.

 

[Brendan Burgess]

The earlier you pay off a loan the better, irrespective of the rate - unless it's a cheap tracker.

Brendan

 

[Tickle]

The advantage of cutting the repayment is that you have a lower committed repayment.
But you are comfortable that you intend to pay this amount in full and clear your mortgage quicker than originally planned, then cut the term and not the repayment

@Brendan Burgess - Say you have a fixed rate mortgage and you can make 10% overpayment per year, and suppose that there is break fee and you don't want to overpay by more. And say your repayment is 1000 euro per month and you overpay the 10% monthly and can continue to do so.

If you choose reduce the repayment with the overpayments then, say the new repayment is 990 euro. If you want to continue to pay 1000 per month, well then 10 euro of this is now coming out of the 10% that you are allowed to overpay.

Reducing the term on the other hand means you can continue to pay 1000 per month + 10% of the capital per year.


In the above scenarios, the capital owed reduces at the same rate each month, but I think by reducing the term would mean you would pay off the capital quicker, because you can continue to lop off 1000 per month + a full 10% per year.

Does that make sense?

 

[Brendan Burgess]

Hi Tickle

Good question.

The general advice here is that you should go for as long a term as possible as you can overpay it. But if you get into difficulties, and you have a shorter term, you could end up in arrears.

Now that most mortgages are fixed rates, that general advice does need to be tailored.

Where you have a fixed rate mortgage, if you plan to overpay your mortgage, then a shorter term is preferable.

However, in most cases the break fee is quite low. So it might still be right to go for a longer term.

But if you have a rock solid job and very predictable expenses, then you might be better off with the shorter term.

Brendan

 

[Pinoy adventure]

@Brendan Burgess

Let’s say mortgage is fixed with AIB and your in a fixed period which AIB allow an over payment of €5000 per year which was done for this year,they send you out a letter with the reduced repayment amount,would the automatically debt the new lower monthly repayment ?
If so how can I still continue repaying the same amount as before the overpayment to reduce the loan quicker ?

 

[Brendan Burgess]

Check with AIB but when overpaying, ask for the term to be kept the same.

However, don't worry too much about it. The fee for early repayment, especially with AIB, is very low at the moment, so you can probably just transfer money into your mortgage account when you want to.

Brendan

 

[boomshine]

Check with AIB but when overpaying, ask for the term to be kept the same.

However, don't worry too much about it. The fee for early repayment, especially with AIB, is very low at the moment, so you can probably just transfer money into your mortgage account when you want to.

Brendan

Hi Brendan / @Brendan Burgess

I mentioned this in another thread (in money makeover) but as I don't fully understand it I wanted to ask on a relevant mortgage overpaying thread such as here.

In summer 2023 I overpaid my mortgage of ~205k @ 3.25% interest (27.5 years remained at the time) and asked to lower the monthly repayment after overpaying 20k euro.
I expected to gain more or less 3.25% on this lump sum but the monthly amount reduced more than I expected. It reduced by about 92.5 euro.
This yearly amount is 1110eur or so which divided by 20,000 gives a return of about ~5.5%.

As it is tax free and guaranteed, for me it trumps post tax investments as the safer ones (EFTs) are taxed heavily at 41% and the less safe ones IT/single stocks are still taxed heavily (ITs get stamp duty 0.5%) with CGT of 33% meaning with ITs or single stocks I would have needed a return of 8.2% to match the mortgage overpayment at my interest rate.

I am not sure if that is because my mortgage is in the early stages (higher interest being paid vs principal) or what reason exactly that the overpayment gives me much more than the expected interest rate of 3.25%.
Similarly if I input here: https://www.ccpc.ie/consumers/money-tools/extra-mortgage-payments-calculator/
That I have a 27 year mortgage @ 3.25% with 184,000 remaining and want to overpay 30,000 again I see an effective rate of return of about 5.5% by reducing the monthly payment not the full term length.

So my question would be - am I missing something and committing a logical fallacy?
If not, then why does everyone just take into account the stated interest rate as the value of return in overpayment rather than this amount being much more?
The savings I make per month can be used immediately and lead to someone increasing their pension with the same monthly amount saved, or even throw that monthly savings into post tax investments etc.

I know the disadvantage of this is that the money is now not liquid but as most of us here invest for retirement / long term then we need to compare long term horizon investments. And although it's not liquid you are still immediately reducing your monthly outgoings which in turn gives you extra cash every single month!

Thanks for your time

 

[Brendan Burgess]

good question and hard to explain but I will certainly try.

Let's take a simple example - you have €12,000 left on your mortgage with a year to go.

Your repayment is £1,027

Now let's say you pay off €3,000

Your repayment falls to $770

So your repayment falls by $257 or $3,084 in total

It's not just the interest which falls, it is the capital as well because you have knocked $3,000 off the amount owed.

Using your argument, you have paid down £3,000. Your repayments were reduced by $3,084 so your return would be over 100%.

This takes a lot of time to get one's head around. So don't worry if you don't follow it immediately.

Brendan

 

[presidenttttt]

Super interested in this query by boomshine. Brendan, not sure i follow the +100% return, on 3000v 3084, isnt that like .03 of 1%?

 

[SPC100]

Have a read of this old post on the topic https://www.askaboutmoney.com/threa...re-paying-10k-on-2-3-20-year-mortgage.210827/

 

[SPC100]

My conclusion from that thread: the financial return is the same, but the series of cashflows are different.

edit:
And unless you are investing the increased cashflow and making more (after tax) from it, than your mortgage rate, you would be better to reduce term!

 

[Itchy]

In summer 2023 I overpaid my mortgage of ~205k @ 3.25% interest (27.5 years remained at the time) and asked to lower the monthly repayment after overpaying 20k euro.
I expected to gain more or less 3.25% on this lump sum but the monthly amount reduced more than I expected. It reduced by about 92.5 euro.
This yearly amount is 1110eur or so which divided by 20,000 gives a return of about ~5.5%.

Consider a 240k mortgage @ 0% for 20 years (240 pmts), 1000 p.m. payment.

You decide to pay off 10%, 24k. Your balance is now 216k over 20 years. Your payment has reduced to 900 p.m.

Your payment has reduced by 1200 per year, 1200/24000 = 5%.

Have you created a 5% return in a 0% rate environment? Yes, you have created a 5% cash-on-cash return but, no, you have not turned lead into gold. Its not an investment return.

As it is tax free and guaranteed, for me it trumps post tax investments as the safer ones (EFTs) are taxed heavily at 41% and the less safe ones IT/single stocks are still taxed heavily (ITs get stamp duty 0.5%) with CGT of 33% meaning with ITs or single stocks I would have needed a return of 8.2% to match the mortgage overpayment at my interest rate.

Your 8.2% is a gross simplification. There is a theoretical hurdle rate that needs to be exceeded for the opportunity cost to definitively exceed the return that you could get from paying off your mortgage. This rate cannot be determined until after the investment duration (hence the tax free/risk free vs. investment risk choice). There are many variables that affect returns that we do not know in advance; inflation, interest rates, economic performance, tax changes etc. The impacts of these can be mitigated in the present by paying off your mortgage today but there is a real (opportunity) cost and why there is an equity risk premium. The opportunity cost of foregoing equity/investment returns is lower when you are carrying a mortgage but is higher when you are not carrying a mortgage.

So my question would be - am I missing something and committing a logical fallacy?
If not, then why does everyone just take into account the stated interest rate as the value of return in overpayment rather than this amount being much more?
The savings I make per month can be used immediately and lead to someone increasing their pension with the same monthly amount saved, or even throw that monthly savings into post tax investments etc.

Yes, but its a question of opportunity cost. If you take your monthly savings and put it on deposit at less than 3.25% you have decreased your real wealth. If you can achieve greater than 3.25% you have increased you real wealth (but then why have you paid off a lump sum?). If the best investment opportunity you have is to pay down your mortgage (like when you had the lump sum initially), then you would keep your mortgage payment the same and reduce the term!

 

[presidenttttt]

Very interesting to see cash on cash return v roi example!!!!

My interest is in calculating ROI really, in order to fully understand cost benefit of investing elsewhere or paying off mortgage.

I have always sought to reduce term in order to reduce total interest paid - so always kept monthly payment the same - and cant really think of a scenario where i would reduce monthly payments, as that would imply there is somewhere better to put the overpayment anyway...