Mortgage overpayment help, anyone clever about?

[Mortgageportgage]

I think I know the answer, but if anyone can advise I'd be eternally grateful.

We have 2 mortgages due to porting one mid-term:
a small one of approx 40k on 4.5%, 8 years left.
a big one of 82k on 2.5%, 22 years remaining.

Which one should I overpay? I've got about £500 a month available. It makes sense to me to overpay the smaller, higher APR one, but even after running the figures I'm not sure as the compound interest on the big one is much greater.

Any wise mumsnetters know?

The one with the highest interest. It will save you more in the long run.

Your payments each year normally cover the interest charged so compounding doesn't really come into. (Your mortgage balance would be going up year on year if it did)

Pay the smaller, higher rate one off.

It doesn't matter that the amount of interest paid on the larger mortgage is more, it will be (despite the lower rate) as the balance is higher. The more you reduce the smaller mortgage the less interest you'll pay overall.

Pay the highest rate one off first

If you feel you have to overpay either of them, pay off the one with the highest rate, always.

The compound interest on the mortgage is irrelevant, it's making the best of the money you're using to overpay that's important, which you do by throwing it at the part with the highest rate.

However, you can get more than 4.5% with a regular saving account, so you could always set up a couple of those instead,

https://www.moneysavingexpert.com/savings/best-regular-savings-accounts/

Definitely the one with higher interest first, but check if there is a limit to how much you can over pay. Some banks say you'll be charged a penalty if you over pay more than 10% of the balance per year.

Pay the highest rate debt first.

It should be unanimous, higher rate first. As pp said be aware of the 10%.

If you are paying c£500 a month to pay it off in 8 years, paying an extra £500 does two things it a) it directly reduces the sum owed b) it reduces your monthly repayments. If you keep your monthly repayments at £1k over time the actual monthly repayment drops so you end up paying even more off the lump sum. In 3 years time you will be amazed at the difference.

If it’s 10%, then reduce the £500 and put the remainder in a high interest ISA. At the end of each year pay the ISA money off the 2nd mortgage. This maximises the tax free interest (more than 2.5%)

Once the higher rate is paid off you can then put the £1k or 10% towards the lower rate mortgage. That will really start to eat into the £82k e.g. £12k a year is £60k in 5 years.

Thank you all so much.
@BarbaraofSeville I see what you mean, but I think psychologically and emotionally we really want to get the mortgage cleared so we can save hard for the dc's uni years / whatever else they want to do.
@Tippingadvice thanks for the in depth reply. My aim would be to clear the little mortgage, then the big one is up for renewal and we could half the term, and be mortgage free by 50 instead of mid 60s. I think I'll throw a party to celebrate!

Pay off the more expensive one first.

@Mortgageportgage the good thing is that once you have paid the mortgages off you can then use the money to a) boost savings for retirement b) have sone fun money.

I retired at 58 having paid of my mortgage at 50.

I do get your dilemma OP.

If you just had a single sum of £500 to overpay, and if either of these rates were fixed-rate-for-the-duration-of'-the-loan then £500 in the 8yr 4.5% mortgage effectively has the impact of £711 (500 × 1.0458) whereas the impact of £500 in the 22yr 2.5% mortgage would be £860 (500x1.02522) so on that simplistic level it feels better to pay into the longer term debt.

However that is built on several wrong bases. Firstly, you are doing this every month and it's not an isolated incident. Eventually future payments will come to bear on the other debt. Secondly, neither rate is permanent, they will both get reset at different points as you rearrange them every 2-5years sometimes higher and sometimes lower. Thirdly it's a mistake to count the money that is "notionally" being saved in years 10-22 as being "of the same value" as money now. It's actually worth much less (I won't attempt to do the more complex sums on my phone but I am sure it outweighs the effect of the compound interest over the same period). And fourthly the reality is that you owe a total of £122k which you will be paying off over the next 20ish years no matter what and putting in whatever you can into overpayments is a great thing, but the only thing you can actually be sure of is the difference between the two rates between now and whichever rate is next up for renewal. Everything else is uncertain an so you will always be better off paying the debt with the highest interest rate first.

We finished paying the mortgage in April (10 years early) so while I’m no financial expert, I think you would be better paying the higher interest debt first. But being mindful of the 10% clause. Once I’d paid the 10% higher interest this year, save it and pay it as a lump sum when the next year starts, keep paying till the 10% is up and then chip away at the other debt until you can over pay the 1st again. That might not be the most financially savvy way of doing it though.
the longer mortgage, is it on a fixed rate of 2.5% for a certain length of time, or is that fixed for the 22 years?

@JaukiVexnoydi I’m sorry but some of your statements don’t make sense.

If a mortgage of £122k is scheduled to be paid in 20 years and the op makes capital repayments of if £500 a month (£60k over 10 years) they will repay the whole amount in roughly 10 years not 20. The op will also pay far less in interest over the lifetime of the mortgage.

£122,000 at 3.5% (averaged) repaid over 20 years = £169,860 total repayment
£122,000 at 3.5% (averaged) with £500 extra a month repayment = £144,760 total repayment and repaid in 10 years. https://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator/

So yes, the op pays back the £122k but they pay £25k less in interest. Yes over time £25k buys less, but it can be earning interest, be invested etc. No, they will not still be paying a mortgage for 20 years.

@JaukiVexnoydi thank you for such a detailed answer. Just wondering if you cold elaborate or point 3 that you made? Many thanks

Overpay the mortgage with the highest rate (with your allowed limit). Just worry about the cost per year of the debt, the length of the term doesn’t matter.

I’ve had one mortgage where the limit was 10% of the original loan, and one where the limit was 10% of the balance at the start of the year. The latter can be a lot smaller than the former, so check which applies to you.