MSE overpayment calculator suggesting it is better to overpay a 3% mortgage than save interest at 4.5%

[honoluluwindow]

I have read many a comment over the last few days that have made me question the overpay v save debate.

My understanding was that the overpayments are affecting interest on a larger debt balance whereas the savings compound from a smaller balance hence it is better to overpay.

I input an example in the MSE overpayment calculator:

https://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator/

I chose a £180k loan, 25 years, 3% rate, £4,800 annual overpayment, 4.5% savings account rate.

It tells me that the loan gets paid off 10 years earlier so total duration of 15 years.

The interest saved is £31,559 vs earned in savings of £30,951 resulting in a net £608 gain for overpaying.

I chose 4.5% to illustrate a higher difference between rates still resulting in overpayments being favourable.

Am I missing something here? Is the MSE calculator wrong?

I also want to point out that I and the MSE calculator are looking at the impact up to the point the mortgage is paid.

I have also used the UKPF calculator which unless I’m using it wrong suggests it’s better to overpay.

 

[bowwoooxd]

@honoluluwindow Quick playing around in Excel gives me:

Scenario A (pay the mortgage and put the £4.8k pa in savings): after 25 years the mortgage is clear and you have around £214k saved

Scenario B (spend 15 years clearing the mortage by overpaying by £4.8k pa, then the remaining 10 years dumping everything into savings): after 25 years the mortgage is clear and you only have around £186k in savings.

So overpaying costs you £30k ish over the full 25 years. I think MSE have gone wrong by only counting 15 years of savings interest, not running it for the full 25.

 

[honoluluwindow]

@bowwoooxd This makes sense and seems to explain the issue, I have emailed them just now so will report back what they say.

 

[rodrigwest]

@honoluluwindow There is no issue at all

 

[resjudicata]

@bowwoooxd Another thing to consider is that the interest rate will not always be at this rate, it may be higher and it may be lower in the future.

It's good to have these 2 scenarios costed out but it will never be that cut and dry

 

[resjudicata]

This just makes overpaying even less of a good idea. Overpaying kills your flexibility because it's much harder to get money out. Cash savings can be used to fund future overpayments if the rate environment changes.

 

[12345susie]

@resjudicata My mortgage is 2.3% for 4 more years. I am putting £1k a month aside into my ISA (vanguard global all cap) and then will take a view in 4 years whether I sell all of it to overpay mortgage at renewal or keep isa investing, depending on the new rate available then.

I think this is meant to be a logical/efficient thing to do but welcome thoughts.

 

[resjudicata]

@12345susie Sounds sensible to me. The downside is perhaps that it is hard to estimate future investment returns whereas comparing mortgage and cash saving interest rates is easy. But yeah in expectation your strategy will give an even better outcome.

 

[12345susie]

@resjudicata Thanks, I am betting that over 4 years I’ll average more than 2.3%, we shall see…

 

[siony]

@12345susie What is your current LTV?

Many mortgages have a 10% overpayment allownace so if you can get into a better LTV band you may reduce your repayments.

Also, some banks have different interest rates based on the amount borrowed - sometimes it's worth borrowing more and immediately overpaying the additional borrowing so that you benefit from a lower rate.

 

[12345susie]

@siony 20% deposit but put another 10% into property in developments or thereabouts so may get some of that back in an upwards valuation

 

[james29]

@12345susie This is my plan (only just bought days ago).

My rates are higher. 3.49% but I've got a 5 year fix and want to buy into a down turned market. See if I get a nice early boost. When thr fix ends. Evaluate the situation at the time.

 

[gobbybobby]

@bowwoooxd I understand what you are saying but isn't this pointless for real world application? No one knows what rates will be for 25 years. If you want to compare shouldn't you just compare for the time period your mortgage is fixed for? That way at least one of the variables is fixed.

 

[hephzibah2014]

@gobbybobby It doesn't matter when you compare it, the answer will always be if you get get a better savings rate than your mortgage rate, put it into savings. I honestly don't know why people over-complicate it. If you mortgage rate is 2% and a savings account offers you 2.01%, you are better off with the savings account. The mortgage balance or term is irrelevant.

 

[lelouch]

@hephzibah2014 Once you hit your tax free allowance and your ISA is full for the year, the calculations change again. But otherwise, yeah 2.01% in interest earned is better than 2.00% interest paid.

 

[logicality]

@bowwoooxd Good catch!

 

[tolearn]

@honoluluwindow The interest saving on the MSE calculator is a purely notional number because it is calculating the interest that would be paid over the full 25 year term, which is obviously something you should know, but that number can not be used in comparison to what interest you earn on the overpayment amount if that is saved elsewhere - they are not parallel.

The fact is, you are comparing 2 scenarios but both scenarios end in being mortgage free at 15 years. So you need to compare:

(1) the interest paid over 15 years if you overpay, vs

(2) the interest paid over 15 years if you don't overpay, but deducting the interest earned over 15 years by putting £4,800 a year in savings

That's it.

The 25 year interest amount is irrelevant because neither of your 2 choices will ever result in you paying 25 years of interest.

So in (1)

you will pay apx. £45,000 in interest over 15 years (MSE doesn't give the exact figure so I've had to work it out approximately)

and in (2)

you will have paid £62,042 in interest over 15 years, but have earned £30,951 in interest, so the net interest paid by you is £31,091. After you pay off the mortgage with the savings at this point, you're about ~£14k better off.



Or if you look at your overall position after 15 years:

With overpayments:

- Your mortgage balance after 15 years is £0

- You have £0 savings

- You have paid £224,471

Without overpayments and with saving @ 4.5%

- Your mortgage balance after 15 years is £88,389- You have £102,951- savings (£30,951 interest*, £72,000 capital)

- You clear the mortgage at this point leaving you with £14,562

- Your mortgage balance is now £0

- You have £14,562 in savings, so- Your net cost is £209,909

Again, after you pay off the mortgage with the savings at this point, you're about ~£14k better off.

* - £30,951 in interest is the figure you would have if you saved £400 per month, not £4,800 per year. https://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php

It's worth pointing that out because on the MSE calculator, you've selected to apply the overpayment as annual lump sums, but where it calculates the interest generated on the savings account, its giving you the figure based on saving £400 monthly instead annual lump sums.

 

[resjudicata]

@honoluluwindow Interest differential is plus 1.5%. Better to save than overpay.

 

[cqbchase]

@resjudicata As long as you can trust yourself not to spend it.

 

[resjudicata]

@cqbchase That's why I stuck my surplus in my pension scheme.