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

[dubhlainn]

@resjudicata But then you can't get it out again until you're 55?

 

[shstlws01]

@dubhlainn 57

 

[resjudicata]

@shstlws01 55 for me if I'm 54 now?

 

[shstlws01]

@resjudicata Yes 55 for you

 

[resjudicata]

@dubhlainn I'm 54 now....

 

[honoluluwindow]

@resjudicata This answer suggests the MSE calculator is wrong which I think it is

 

[slaw7777]

@resjudicata Why though? Sorry, I just don't understand the maths either?

 

[greatlakes4ever]

@slaw7777 Imagine if you had a 10% interest loan and a 10% savings account.

Overpaying by £100 into the loan saves you £10 after a year.

Putting the £100 into a savings account makes you £10 after a year.

Both actions have the same effect on your net worth.

It shouldn’t be hard to see that if the savings account had a higher interest rate than the loan, then it would be better to put money into it (and vice versa).

 

[rodrigwest]

@greatlakes4ever Wrong.

If you pay less interest on your mortgage but your monthly mortgage payment (+overpayment) is the same you overpay your saved amount. And it adds up with time. So amount of future interest reduces more.

Also you never pay tax on your overpayment but not necessarily true with interest.

One more thing - you make overpayments by say £100 a month. You should count interest for your savings like £100 5% for first month £200 for second etc. But do you have a high interest account which is not fixed and allow to make additions ?

If you have all the money at once you could just reduce your mortgage.

 

[filu63]

@rodrigwest

And it adds up with time.

So does interest on savings. If they're at the same rate, they're exactly equivalent. If not, higher rate is the most financially efficient.

 

[slaw7777]

Is it as simple as this? https://www.finder.com/uk/should-i-overpay-a-mortgage-or-save

 

[podpkid]

@slaw7777 Not an expert, but guessing it might be due to taxes on gains from savings in interest.

Edit: basic tax payers have a limit of £1000 before interest from savings is taxable.

If you have 20k in the bank getting 4.5% that's pretty close. So in the last few years, >20k savings you will be paying tax on the interest.

Higher tax payers the limit is only £500, so unless you overpay before you got this limit, your taking a haircut each year no?

 

[honoluluwindow]

@podpkid Don’t think this is the case, they give you the option to apply various tax rates if you want, I selected None.

 

[podpkid]

@honoluluwindow Ahh okay, like I said not an expert but could be worth thinking of. Just thought it's unlikely MSE would make a mistake this big on a calculator...

 

[honoluluwindow]

@podpkid I think they have to be honest, you are absolutely right about the tax on savings just that I’d not ticked that option purposefully as the calculator says that. It’s also one where you may not pay tax early on but as the balance increases on your savings account, you certainly will and so this would in fact swing in overpayments favour.

 

[ruthracheal]

@podpkid Im not sure why you were downvoted, this is a good question and easy to overlook if you aren’t used to saving.

 

[podpkid]

@ruthracheal Meh, it's okay. Probably will filter non expert opinions. Tbf I could have looked at the option on the MSE website.

 

[alcwj]

@honoluluwindow You pay tax on interest from savings, it's income.

20% rate payers get a £1000 allowance whilst 40% rate payers only get a £500 allowance.

So if you're actually talking about amounts that make this stuff worthwhile then you're effectively paying £400 in tax for every £1000 earned.

That's not a reason to not to do it, £600 is better than £0, it's just something that will significantly impact your returns.

If you're retired, or can make use of your partners personal allowance (e.g. stay at home mum) then it becomes a lot more attractive.

 

[rnblessings]

@honoluluwindow Looking at the results box:

If you had instead put the overpayment into a savings account paying 4.5%, you'd have made £20,316 in interest over the same period (ie [the shorter time period that presumes you overpaid anyway]).

Taking this into account, there is a net gain from overpaying of £2,606.

I'd have thought the better period to compare to would be the length of the mortgage without any overpayments, if you're not actually making any in order to put into savings.

(Whether this would change which would be better, I'm not sure, but it's something that did seem off to me.)

 

[deedee79]

@rnblessings Okay so at 25 years either way you'd own a house outright

£400/m for 25 years nets £102,297 interest
£400/m for 25 years leaves you with a balance of £222,296

If you took the mortgage payment + repayment into the 4.5% saving account after paying off the mortgage (so for 10 years) you get:

£1253/m for 10 years nets £39,885 interest
£1253/m for 10 years leaves you with a balance of £190,245

Long term it is better in the saving account

Edit: It makes more sense to look at balance rather than interest