To ask someone to please explain sodding compound interest and mortgages to me

[Lucycantdance]

Mortgage on a 30 year term, two years in. We overpay already but just arranging to overpay more as both had decent pay rises. Have just fixed for five years on a brilliant rate.

When I use the overpayment calculator it seems that the term just reduces in a consistent way i.e. doesn’t speed up - which is what I thought it would do the more I increase the overpayment due to the mysterious “compound interest”. How does it work - does it speed up? Someone explain it to me like I’m five please? I guess when all is said and done just overpay what you can afford is going to beneficial no matter what?

You need to ask your mortgage lender to use your overpayments to reduce the term - it's not how they will automatically do it. Otherwise, they just apply it to your 30yr mortgage and reduce your payments over time but the length remains the same.

If you overpay you have to specifically ask them to reduce the term. Your monthly payments will be slightly higher but you will pay less interest overall

Compound interest means you pay interest on the interest. In the first third of your mortgage at least most of your monthly payment will be interest, not capital. Over time this shifts.

Which calculator are you using?

Also am assuming you have checked there are no penalties for overpaying?

You can choose to make the repayment reduce the term; it's not automatic

And yes, watch how much you overpay as there may be penalties if you overpay too much

God I had no idea. I’m using the calculator on the log in thing. We can repay up to 10% without penalty. I’m so glad I posted 😬

Yes they generally try and avoid you paying off early (because they make less money from you if you do!) So the default is for overpayments to reduce your monthly payment required, not reduce your term.

Watch out with capped over payments and fixed rate periods. They are often set as a % of outstanding balance meaning you are limited in how much you can overpay over time. In these circumstances it's a good idea to put anything you can't over pay into an isa and whack it off the balance as soon as your fix is up.

Are you doing the calculator right?
Here’s the MSE one for Overpayment.
£200K for 28 years @ 1.5%, with a £200 per month overpayment.
See how in year one the debt goes down by approx £8K, but by year five it’s closer to £9K? And the graph shows the curve speeding up too.

Have you looked on MSE? There are calculators for lots of things on there.

Secondly, when is your interest calculated on your mortgage? Way back in the 1990s, mine was calculated annually on 31st December. I used to stick the cash I was intending to overpay with into a savings account during the year and earn some interest (oh, the days when you could earn interest!) then on 29th December, withdraw the cash and walk over to the building society to pay it off against the mortgage. When the annual statement came out, they would invariably reduce the amount payable rather than the term, but I would keep the amount the same and repeat the process to reduce the term. Now I think interest is calculated more often (daily?) but you need to check that out.

Finally, in any mortgage, the first few years are just about paying the interest and the capital is hardly touched unfortunately, so you probably won't see the debt reducing for a while yet.

It depends on the lender I think as pp have said be specific with what you want them to do with your overpayments

Best to actually speak to someone there and get the right information.

OP is it 10% of remaining balance? Be aware that it will reduce over time as your balance reduces.

Going to look on MSE now. Thank you thank you thank you so much already.

@Lucycantdance here’s a link:
www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator/

As PPs have said, the MSW calculator is great and very illustrative.

In the early years of any mortgage it feels like a drop in the ocean as the interest is such a huge part of the repayments. But the compound effect means it speeds up the more you go on,

If it’s a variable interest rate they should be flexible on paying off more without any penalty at all. A fixed rate mortgage you are contracted to pay a certain amount over say 5 yrs there may well be a penalty if you don’t.
Mortgages get paid off before their end date all the time, when you move house, what they don’t like is extra admin time for small changes, so unless it’s a large sum invest it in an ISA and keep flexibility as well.

“what they don’t like is extra admin time for small changes”

Overpayments are done entirely via automated processes though. My building society neither likes nor dislikes my overpayment - it causes them no additional work. In theory they might “dislike” the lost interest to them, but even that’s a trade off - a mortgage with easy over payment process might attract me as a customer, or I may later take on more borrowing because I paid off early. It’s just a product for a type of customer that they’re happy to make money from - no like or dislike or admin about it.

‘ Compound interest occurs when interest gets added to the principal amount invested or borrowed, and then the interest rate applies to the new (larger) principal. It's essentially interest on interest’.

From google.

I would also consider how much the mortgage is costing in interest and whether you are actually better off overpaying. Interest rates are so low at the moment you might think about investing your spare cash instead.
I’m paying 1.09% on my mortgage and getting an average of 5% on my stocks and shares ISA, so I’m putting extra money into ISA with the view to using that to pay off a chunk of my mortgage if interest rates rise significantly by the end of my fixed rate deal.

Yes, the mortgage companies expect you to have, say, a 30 year term, so if you overpay now, they just spread that overpayment out against future expected payments (i.e. your future repayments are lower than the amounts they said they'd be when you first took your mortgage).

You'll notice the difference at the end of your 5 year fixed rate when your balance will be significantly less than it would have been had you not overpaid.

When my fixed rate term comes to an end I always get a new mortgage with a slightly reduced term, even if it's only one year less (i.e. if you signed up for a 30 year mortgage with a 5 year fixed rate, at the end of the fixed rate term get a new mortgage for, say, 24 years).

I don't find the repayments change that much (especially as you're already overpaying) and it instantly wipes a year off what's left.

Hi, OP. We're moving your thread to Chat now.

Thanks everyone. Spoke to the bank this morning and I get it now. We didn’t reduce the term when we refixed but we’ll make sure the overpayments reduce the term. Really appreciate the advice.