Overpaying Mortage Early vs. Later?

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spida

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A friend is forever telling me that over-paying your mortgage early is much more beneficial than later in the life of the mortgage. This is apparently because early in the life of the mortgage, what is being repaid is mostly interest. For some reason I just can't imagine things to be that simple.

I ask now because for the first time in my life I'm about to sign on the dotted line and kick-off my own mortgage. I don't imagine there'll be huge amounts of unwanted ca$h lying around to use for over-paying but if it is just as beneficial as my friend says I might just do whatever it takes to over-pay a bit.

Please tell me if my friend is right. ls it really that simple? Over-pay now rather than later and you'll wipe Years off your mortgage???? Really?
 
leonmahon said:
Any overpayments will reduce the capital...
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Thanks for that leonmahan. The question is more about overpaying at the start versus later in the life of the mortgage and is it very much more beneficial to pay off Eur100 extra at the start (for the first two years lets say) vs. at year 10 for two years.
 
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In simple terms, if you overpay by 100 a month for two years, you have paid off €2400.

If you pay this off in year 2 of a 25 year mortgage, you will not have to pay interest on this money for 23 years. You save 23 years of interest.

If you pay this off in year 12, you will only save 13 years interest.

Using 5% interest rate and ignoring compound interest, the interest on 2400 is 2730 over 23 years and 1560 over 13 years.

These numbers are a simplication and not exactly correct, but should give you an impression of why paying off earlier eaves more money.
 
Yep, this is true. I think the best way to get a feeling for how it works is to play with adding an "extra" payment on Dr Calculator from Karl Jeacle.

A simple example I did shows an extra payment in month 24 (year 2) of 10,000 saving over 25,000 in interest over the lifetime of the mortgage. The same 10,000 extra payment in month 240 (year 20) only saves about 5,500 in interest. This is because you are paying to borrow the money and the interest compounds. If you pay the 10,000 off after 2 years, you have only borrowed that 10,000 for 2 years rather than 20 years - or that's how I think about it anyway. I left all the other settings at the defaults when doing this example.

(Obviously this works the same for smaller overpayments - I just found the 10,000 example made a big impression on me!)
 
spida said:
The question is more about overpaying at the start versus later in the life of the mortgage and is it very much more beneficial to pay off Eur100 extra at the start (for the first two years lets say) vs. at year 10 for two years.
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Assuming an interest rate of 5%;

If you paid an extra €1K off your 20 year mortgage in year 1, then you would save €50 in interest annually for 20 years, that’s €1,000 of a saving.

If you paid an extra €1K off your 20 year mortgage in year 10, then you would save €50 in interest annually for 10 years, that’s only €500 of a saving.

The simple answer to your question, I think has to be yes, it is more beneficial to overpay at the start.

To maximise your saving, you should also tell your lender that any extra payments should reduce the term rather than reducing the monthly repayment amount over the existing term, different lenders have different default policies in this regard.
 
Slightly complicated by the fact that the value of the euro you use to overpay today is greater than the euro you will use in 10 years time.

I would imagine any calculation would have to take the future value of money into account. Interest rates of mortgage, possible tax benefits, deposit rates available etc etc. might not be as straight forward as you suggested.

1 euro today may be worth equivelant of 90 cent in ten years.
 
spida said:
A friend is forever telling me that over-paying your mortgage early is much more beneficial than later in the life of the mortgage. ... ls it really that simple? Over-pay now rather than later and you'll wipe Years off your mortgage???? Really?
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In assessing whether to pay down some extra money off your mortgage, you are basically deciding whether or not to invest money for a very long term to earn 5% (or whatever your mortgage rate is) per annum net of tax on that money. And that’s it. There is no magic money, there’s no leveraging of your investment to get a 5x, 10x, 20x return. Your rate of return doesn’t increase if you make the paydown sooner – it’s still 5% per annum – but obviously, the longer you 'invest', the greater your return in pure € terms. 5% pa net of tax is a very solid return on your savings but it’s not a spectacular, once-in-a-lifetime return worth eating porridge and baked beans for years on end to achieve.

If you want a long-term ‘lock away my money so I can’t spend it’ investment (which is what paying down your mortgage is), you might be better investing in a pension if you are a higher rate tax payer and can find a low-cost pension. You get tax-relief on the way in, returns compound tax-free within the fund and you can get 25% of your fund tax-free at retirement. Depends on your age and mortgage term but it's probably not much longer-term an investment than paying down the mortgage.
 
There really are no simple answers! Thank you all for your replies. I'll have a look at what I'm left with each month and whether I'll be able to afford the beans on toast before deciding what to do!

The pension idea is a good one. Also, taking into account the value of the Euro and ensuring to reduce the term rather than the amount.

Thanks all.
 
I was thinking of how best to answer this question, but Orka has hit the key points very well.

1) Judge it by the annual saving or return on investment
2) Don't live on beans and toast so that you can invest money at 5% return.


Brendan
 
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