Which would be cheaper in the long run?

"nospam" wrote

What are the two relevant interest rates, and what is your marginal tax rate??

Firstly, if you save in a normal high interest account you'd be taxed on it, thus reducing your return and meaning that you would not end up with 12K unless you put it in an ISA. You can put 3,000 per year into a cash mini-ISA. Your partner, if you have one, could do this as well, thus accumulating 12,000 over 2 years. The rest would have to go into an account where you would be taxed, unless one or other of you were a non-taxpayer. But have you got a spare ISA allowance this year or have you used it?

Secondly, what is the difference in interest rates between your fixed rate and the net rate you'd get from a deposit account? If the fixed rate is higher, which it probably is if you've only just taken it out, then you're better off paying the mortgage back. However, if bank rates, and therefore deposit rates, go up then you'd need to look at it again.

Rob Graham

1. 4.99%
2. Any high interest rate account / ISA, etc. Standard rate tax payer.

I didn't mention these before because I'm wondering about this issue in principal / generically.

Thanks for responding, but I _could_ save 12k in the deposit account even before interest in 2 years (24x500)!

Yes. that's a good, sensible idea.

So you reckon the answer to my question is that if the fixed rate is more than the net deposit rate then I should pay off the 500 overpayment, but if the net deposit rate is greater it would be better to save that money to pay off at remortgage time in 2 years.

Thanks, I wondered initially if I would pay back more capital by doing the latter, since I plan to reconsider my mortgage in 2 years.

Are you so witless that you think this can be answered without saying what the interest and mortgage rates are, and by how much you would overpay (you say 'up to')? And what your tax position is (high rate or not?).......hmmm, it would appear you are.

Since when has there been a capital tax? It's the interest which will be paid with tax deducted, not the money he pays in which will be taxed. Not that there's anything wrong with saving in an ISA.

In message , nospam writes

It would also be helpful to know the lender's and deposit takers interest accrual period, i.e. monthly, quarterly or annually and at what point interest is calculated by the lender, i.e. daily, monthly or annually.

The answer depends on the interest rates you can get, on whether you are a higher rate tax payer, and whether you normally use up your cash ISA allowance. But in most circumstances you are better off overpaying the loan, because your loan overpayments save you interest on the loan at the loan rate, which is usually higher than the savings rate (net of tax).

For illustration, suppose you are a basic rate tax payer, you have a £100,000 loan at 5% for 25 years (thus monthly payment £578.14), and in scenario 2 you open a cash ISA paying 4.6% and a savings account paying

In scenario 1, you owe £83125.35 In scenario 2, you owe £83167.36

So scenario 1 is better, but with these figures there isn't much in it.

Is this correct:

No extra paid off: 86124.64 (100000 - (578.14 * 24)) Scenario 1: 74124.64 (100000 - (1078.14[500+578.14]*24)) then less interest saved through paying off quicker. Scenario 2: 74124.64 (86124.64 - 12000 (500*24)) then less interest earned on 12k).

I guess my point was that eventually after potentially remortgaging every 2 years over the 25, whether there would be a more convincing obvious clear winner in terms of true cost. But I guess what you are all saying is that there is no obvious winner without specifics - I was thinking in terms of concept when I asked my initial question.

Thanks.

I assumed that would be taken for granted but, sorry, I was wrong to assume that.

Rob

By the way, your scenario 0 is wrong. If you pay £578.14 a month for 24 months, you will *not* reduce your £100k loan to £86125. Most of the £578 payment is interest, only the excess above interest actually reduces the balance.

If you're thinking of regular remortgaging as a matter of policy, you will realise that the more lucrative rates are only available to those who pay up-front fees. Even then, there are ancillary costs involved (legal, survey). Some remo deals involve the new lender paying these for you, but the more lucrative ones tend not to, and you need to do your sums carefully to verify that the costs of the remo process don't outweight any saving you make on the rates.

The point really is that the interest saved in scenario 1 will be more than, the same as, or less than that earned in scenario 2, exactly when the loan interest rate is higher than, the same as, or less than the net savings rate.

Take your existing mortgage loan, on which you say the payments are £578.14pm. If it were interest-only, they would be £415.83pm (for £100k at 4.99%). The loan balance reduction profile is in fact exactly equivalent to overpaying the difference, £162.31pm, relative to an interest-only loan balance of £100k, into a savings account paying

If by some quirk you could actually find a savings vehicle which, without risk, would give a net return in excess of 4.99%, you'd be better off immediately converting your loan to interest-only, reducing the payments from £578 to £416, and putting the difference into the savings account. But it's unlikely that you would find that, and for the same reason it's better to overpay th loan.

The loan reduction in effect works *exactly like* a savings account, at the loan rate, except that the "capital ammassed" is a lowering of debt instead of an increase in credit, but the two are equivalent.

In that case then, I'd always opt for either the savings account approach (since you can never tell how life will go and you may want to lay your hands on that money at some point) or an over-payment-reserve type mortgage which you can draw on if necessary.

No, you have to take interest rates into account. Generalisisng, there do of course exist forms of debt other than with mortgages. You wouldn't say the same about credit card debt, would you? And why not? Because there the interest rate differential is rather more extreme. So it comes down to where you strike the balance between interest rate differential and the need for adequate rainy-day reserves.

I suggest you should first build up a reasonable emergency fund capable of being drawn on immediately, but there is no need to let this become too big, since it is usually possible to withdraw overpayments even from a loan account not branded as "flexible", since even with mortgages which discourage frequent overpayments there is usually the option to take a "further advance". Your cash reserves therefore really need only bridge the delay involved in applying for, and getting, such an advance. Beyond that, there is no point having your money sitting in a savings account earning

Paying off debt is a particularly good idea if there is even the remotest likelihood of ending up in negative equity should your property value drop.

No, these calculations are wrong because you neglect to work out the interest charged on the loan and paid on savings.

It's easier to see what's going on if we consider a single month with payments at the beginning of the month.

Scenario 1: you pay £1078.14 to the lender, leaving £98921.86, on which the lender charges £403.02 interest. Balance: £99324.88.

Scenario 2: you pay £578.14 to the lender, leaving £99421.86, on which the bank charges £405.06 interest. You pay £250 into the ISA, earning £0.94 interest and you pay £250 into savings, earning £1.22 interest (on which you pay £0.27 tax). If you paid off the loan with your savings at this point, you'd leave a balance of £99325.03.

So in scenario 1 you are £0.15 better off after one month than in scenario 2. (The difference is small because the savings and loan rates are very close.)