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Don’t shorten your mortgage term if you can overpay

Don't shorten your mortgage term if you can overpay

Don't shorten your mortgage term if you can overpay

This morning a nice lady approached me to ask a quick question about her mortgage. She said that thankfully, her finances were in a good state and she had a cheap variable rate mortgage, so she was considering cutting her mortgage term to be able to clear the mortgage much more quickly.

On the surface this is eminently sensible. Decreasing the term means you pay it off more quickly, which means there is less time for interest to accrue, so you pay less overall.

However, while it is sensible, my question to her was: "I presume you can’t overpay the mortgage?"

She told me she could – in fact she had a mortgage with fully flexible features that allowed her to overpay and even borrow back if she wanted to without penalties.

Overpaying has the same impact as shortening the term

This left me slightly stumped because overpaying has exactly the same impact as shortening the mortgage term, but with the great advantage that you can stop doing it if you want or need to.

Here are some example numbers to prove the point…

  • A 25 year 3% interest repayment mortgage on £200,000
    Monthly cost: £948 | Annual cost £11,380 | Total interest over 25 years: £84,530
  • Shorten that to 20 years
  • Monthly cost: £1,109 | Annual cost £13,310 | Total interest over 20 years: £66,210

As you can see, shortening the term increases the monthly cost, but cuts the total interest by £18,000 – a monumental saving.

Yet she would end up with a very similar result – both in cost and in the time it takes to clear the debt – by overpaying by £160 a month or a lump sum of £2,000 each year – the difference between the cost of each mortgage. (I say similar and not exactly the same as timing issues, and when the interest is calculated, can have a small impact).

If you can overpay your mortgage (and by that I mean choose to pay a variable amount more on top of your set repayments without penalties – rather than formally changing the amount you pay), it’s worth playing with our Mortgage Overpayment Calculator, which shows the impact of single or regular overpayments.

Overpaying is far more flexible

The real key here though is that she said her mortgage is at a variable rate. That means if interest rates rise, as many predict they will, her monthly costs will increase anyway. That could make the payments of the shortened term unaffordable – and there is no guarantee if you shorten your mortgage that your provider will allow you to increase it again (this can be much more difficult to do).

This could mean mortgage arrears because of the inability to pay over the shortened period.

Yet with overpaying, you could simply stop doing so by the same amount, giving you the freedom to control payments.

Overpaying isn’t for everyone

Before you start overpaying – assuming there are no penalties (or shortening your term as the impact is similar) there are a couple of things you need to think through. The first is contrasting the benefit of it against straight savings.

The simple rule of thumb is if your mortgage rate is higher than the after tax rate you can earn on savings, it generally pays, if not – for example, for someone on a very cheap legacy mortgage – you are likely to be better off saving rather than overpaying (best tactic is to put the cash aside ready to overpay in case/when rates rise).

I’d also suggest that before dunking the cash into your mortgage, you consider building up a cash emergency fund of six months worth of bills. This way if something happens you’ve got the cash put aside – rather than locked away in a mortgage (and the fact you’ve overpaid won’t stop them putting you in arrears). For far more on this and much more help see the Should I overpay my mortgage guide.

Thoughts below please.

PS. Having read some of the feedback, it seems after overpaying, some lenders automatically decrease your normal payments. Of course this can help some with cashflow but it doesn’t have the interest and term reduction effect that this blog is about. So when you overpay, ask them to ensure your standard repayments remain the same.

Other ‘interesting’ mortgage stuff I think you may like…

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Foodbank financial triage – an update

Foodbank financial triage – an update

Foodbank financial triage – an update

In August I blogged that I was going to fund a radical pilot scheme to get financial triage into foodbanks with the Trussell Trust.

The idea is that when people are asking for food, it’s a great time to try and help them manage their money and see what help is available – so hopefully the trip to a foodbank (to which people are often referred by a health or social agency) will be a one off.

For full details on the scheme and my involvement read my I’m excited to be involved in financial triage at foodbanks blog post.

The Trussell Trust has just sent its first progress report to me, so I thought I’d share it, as I know many of you were interested.

"Six food banks have been lined up to participate in the pilot. They are:

  • Hammersmith and Fulham
  • Stroud
  • Coventry
  • Cardiff
  • Durham
  • Dundee

Plus Tower Hamlets which we will wind into the pilot as they have already implemented a programme which is still running. No money will go to them directly, however we will include their results.

We have lined up and have spoken to all initial Partners: CAP, Turn2us, CMA, Money Advice Trust, CAB.

Following all press including Martin‘s interview, the Trussell Trust received 57 enquiries from potential partners wishing to participate in the pilot. Whilst the above listed have been chosen to participate, the others are being managed until such a time it is appropriate to proceed with them.

Computers have been organised for all trial Partners (at nil cost to the project, sourced through Avios air miles promotion by being their charity partner).

David has visited Northern Ireland where he has put the wheels in motion as follows:

  • Set up and agree terms for NI ( Northern Ireland) using Advice NI.
  • Advertised for a Project Coordinator. Interviews will be held on 13th October."

So we’re about to be up and running. It’s great to see so many people engaging with this.

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Cancelling the 55% tax on unused pension pots could be a disaster for many older people

Cancelling the tax on unused pension pots could be a disaster for many older people

Cancelling the 55% tax on unused pension pots could be a disaster for many older people

In the last Budget, Chancellor George Osborne announced he was freeing up much of the pension market so people could take their  money when they wanted – 25% of it tax free and the rest at their income tax rate.

Today, at the Conservative Conference, he has said  that if over 75s do that and die, and there’s money that hasn’t been touched in their pension pot yet, instead of their estate paying the current 55% tax when its passed on; they’ll pay it at their marginal rate (full info in the death tax news story).

This is a big pre-election giveaway to older voters, likely on the back of the scares about UKIP defectors. At a first glance, both these proposals seem wonderful, giving people more choice in the pension market and a greater ability to leave it to their dependants. (I shall ignore the wider  philosophical debate over cuts in inheritance tax – which is a tax to stop perpetuating inherited privilege and wealth – that’s a discussion for another day).   
Yet I have some real concerns over unintended consequences – so I’m quickly bashing out this blog as a stream of consciousness. I’d love to know your opinion on it.

The issue isn’t people overspending, it’s people underspending

When the pension liberalisation policy was first launched, one big headline concerned the risk that people would  simply cash in their pension, buy a Porsche and the state would have to look after them in their old age.

Of course this can happen, but I suspect only with a trivial number of people. In fact as I explained in my The Chancellor’s pension changes are wonderful and horrid blog, the real worry for me is the opposite of this.

I am concerned that someone who has a pension – be it  £20,000 or  £200,000 – when they retire at say 67 knows it must last them the rest of their life, and a natural fear means they will be very reticent to touch it.
 
It will be left sitting there and that worry that if they spend it now they will have no money later on  in life, means they will leave it there growing but unused, not helping them in their life in the way that a pension is designed to.

That was the one  benefit of an annuity: you cashed your money in and you got a payment each year for the rest of your life – a real genuine income. The big problem with annuities of course, was that the amount that you got wasn’t big enough.

Under the new system of pension  freedom, the only way to really decide how much you should be spending each year is to know when you will die. Now that isn’t that easy, although actuarial charts and your health and situation can you give you a rough indication of when this will be.

Of course you could get it wrong, so as a rule of thumb I would assume you are going to die 10 years later  than the prediction and spend your money accordingly. But I simply don’t believe people will do that. Take these examples…

If you look at people who saved up for retirement planning to live off their savings in the bank (as opposed to pension savings). With interest rates lower than inflation, effectively the money is shrinking. Therefore it makes logical sense to spend some of the capital to live off, as the income isn’t enough. 

Yet the psychology of it means people are, albeit understandably, simply are unwilling to spend the capital that they have; they only want to live off the interest.

This situation I suspect will be mirrored for many in not using the cash in their pension pot too quickly.

The cutting of tax could make that worse

The idea is that the money can be just as efficiently left to your inheritors as it is for you to spend it. I think this will perpetuate this psychological problem. Of course, there are some more affluent people who will see it as a great way to be able to leave money to their dependants by not touching their pension and using other funds.

Yet many on lower incomes already have guilty old ages, worried they’re "spending my child’s inheritance", even though sometimes their children are more affluent and have better lives. Pension money is meant to be there for you, not your dependants, to give you a decent standard of living in your old age.

Yesterday when I was filming for my  television roadshow, I spoke to the son of a woman who had a decent but not huge of  amount in savings who was desperate to give it away to her children to avoid  inheritance tax. She was 78 and in decent health, but what was she going to live on for the rest of her life?

So indeed my great fear with this change is more people will restrain and constrain their spending far too much on money that is supposed to support them – knowing it could go in an efficient way to their kids.

Would guidance and education alleviate the worry?

The Chancellor has said he wants people to take guidance when they take their pension so they will understand these issues. The amount of money initially put into the pot to fund this -  up to £20m for the first two years – is actually relatively small for giving guidance to all pensioners; certainly if advising them the way I would prefer, at a proper level where people will take liability for the advice that is coming across, rather than what could just be generic twaddle if not done right.  

So my great concern is not that I have a principled objection to the freedoms of the pension market, nor even  necessarily to allowing people to inherit with lower tax. What I do worry about  is that we do have a primarily financially underskilled population who are not equipped to deal with these issues.

We already know that from the fact that when  people retired in the annuity market, even though there was an open market  choice where they were able to go right across the market to get the best  annuity rate, the majority of people (60%, according to a 2012 study by the Association of British Insurers) didn’t do that. Instead they just kept with their pension provider’s annuity so losing income every year for the rest of their life.

I don’t think that enough of the current generation retiring population (especially those with smaller pension pots) are well equipped enough to deal with the freedoms. You may call me paternalistic, but I think we need more protections in place to help people manage their finances well when they retire.

I’d love your thoughts?

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Try the new mobile friendly MoneySavingExpert.com

Try the new mobile friendly MoneySavingExpert.com

Try the new mobile friendly MoneySavingExpert.com

We’re in the midst of a huge exercise to make the main site more mobile friendly guide by guide (this blog hasn’t been made more mobile friendly yet, so don’t judge the project on this). In fact, what we’re actually doing is making the site responsive. In other words, the page will scale and change depending on how big your screen is.

So while the content will always be the same (we decided not to cut it down for mobile – if it’s important enough to say, we should say it regardless of the format), it will look different on a smartphone, tablet, laptop or desktop monitor.

This isn’t the first time I’ve mentioned it. I wrote last December that we were starting the project in my Making MSE work better on mobiles blog post and I wanted to update you today on where we are.

It’s actually been a much bigger challenge than we first thought. To make it work, we’ve had to effectively redo each guide for desktops too. We’ve now got a great team working full time just on this though so you should start to notice a difference quickly.

Here’s one we prepared earlier…

Take a look at our 35 ways to boost your credit rating guide on your desktop and on a mobile to see the type of thing we’re doing (note the change to 35 tips isn’t part of this, that was a deliberate style change just for this guide – and not part of the ‘mobilisation’).

I hope it renders well for you and is much easier to read now it fits well on the page. However, it’s not fully finished. In the next couple of weeks we’ll be adding an ‘In This Guide’ hamburger menu icon to all the mobile-optimised guides. You will then be able to click on this to see (and easily navigate to) all the chapter headings and sub-headings of a guide.

PS. The forum is in the midst of a redesign too. Logged-in users will be able to try the new version and many have been using it for months.

What’s the rollout plan?

There are already a good number of articles and guides on the site that have been updated in this format and over the next couple of months, a big chunk of the rest of the content will also be done.

Once that’s done, it’s time to work on the taxonomy of the site – in other words, the navigation structure of the sections – and then once that’s done, we can redesign the home pages and section pages to be more responsive too. After that, we’ll tackle some of the big site tools.

Do let me know what you think of the mobile friendly articles, are they doing it for you?

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Ad watch – NatWest’s 0%uch ad is dangerously misleading

Ad watch – NatWest's 0%uch ad is dangerously misleading

Ad watch – NatWest's 0%uch ad is dangerously misleading

The semi-publicly owned bank has funded a huge ad campaign to declare to people the danger of 0% cards. From full page newspaper ads to viral videos, it’s trying to persuade people its stance is in their favour. So I wanted to bash out a quick blog to put that to the test.

Its newspaper ad screams out at you…

"No to 0% credit card deals because they have rates that jump up and sting you once the rates end".

It then goes on to promote its deals…

"We offer credit cards with no sting in the tail. They’re fair. They’re transparent."

And it even has a propaganda video:

So let’s compare NatWest’s self-vaunted fair offering with what the nasty, boo-hiss 0% stingy cards are offering.

What the NatWest credit cards offers

Its big deal is its NatWest Clear Rate card, a simple low rate card of 6.9% annual interest on all balance transfers and purchases. All sounds nice but as its ads are very concerned about ‘stings in the tail’, I thought I should warn you of, yes you guessed it, a couple of stings in the tail.

  • There’s a £24 annual fee. This is thankfully a rarity for mainstream non-rewards credit cards. Incorporate this into its interest rate and it’s 11.1% representative APR.
  • You may be accepted but pay a higher rate. As NatWest is campaigning for transparency, let’s be very clear. The fact this is a ‘representative’ APR means it, like almost every card, only needs to give 51% of accepted customers the advertised rate. The rest can be charged more.

There are better stable rate cards than NatWest’s

NatWest’s offering isn’t an awful deal, there are far worse on the market. Yet there are certainly far better cards with similar non-0% deals.

As a straight comparison my top pick, similar, stable rate card is the MBNA Low Rate which is 6.6% representative APR – so lower than NatWest – and crucially no annual fee. Overall that’s a big saving.

How does NatWest compare to those 0%uch cards?

Of course, what NatWest’s campaign is all about is bad mouthing 0% deals that sting you by bolting up the rate at the end of the deal. So let’s see how it actually compares. Three housekeeping notes before I do that…

  • I’m comparing it to the best cards on the market. Of course there are poor 0% cards too, but as it’s attacking the entire concept, this seems fair to me.
  • I’m assuming you don’t do the right thing and tart. The best way to use 0% cards is disloyally shift from 0% card to 0% card as soon as one deals ends. That irrefutably cuts card debt far better than any other method; and smashes NatWest. Yet to be generous, I’m going to assume people use 0% cards and don’t shift once the 0% ends.
  • This all depends on acceptance. Of course the calculations are moot if you get rejected. To see which cards you’re most likely to get use the free eligibility checker tool.
  • These are spreadsheet calculations. Interest calculations vary between card providers, so treat these as good back-of-the-envelope calculations rather than exact.

FIGHT 1: NatWest v 0% balance transfers

Let’s start with what 0%’s are famous for – debt shifting balance transfer cards. Here the big beast on the market is Barclaycard’s current offering. It allows you to shift debt at a huge 33 months 0% with a one-off fee of 2.99% followed by 18.9% representative APR afterwards. For more options and info see Top Balance Transfers.

Debt remaining on £3,000 shifted, repaying fixed £100 a month
After 1 year After 2 years After 3 years After 4 years After 5 years After 6 years After 7 years After 8 years After 9 years After 10 years
Barclaycard £1,890 £690 - - - - - - - -
NatWest £1,994 £919 - - - - - - - -
Debt remaining on £3,000 shifted, repaying MIN REPAYMENTS
Barclaycard £2,347 £1,786 £1,412 £1,252 £1,110 £983 £872 £773 £685 £607
NatWest £2,658 £2,354 £2,085 £1,847 £1,636 £1,448 £1,282 £1,135 £1,005 £889

So here Barclaycard smashes NatWest.

  • Repaying £100 a month, Barclaycard is £229 cheaper.

    With Barclaycard, you’d clear the £3,000 in 31 months and the only cost would be the £90 transfer fee. With NatWest, it’d take 34 months and you’d pay £298 in interest and £48 in annual fees.

  • Repaying just the minimum repayments, Barclaycard’s 0% still wins.

    Barclaycard is far cheaper in the first three years (when it’s mostly at 0%) and by that point, you’’ have cleared £600+ more debt; meaning you’’e less debt to accrue interest. Of course the best practice at that point is to shift the debt again to another 0% deal (see Cheap balance transfers).

    But even if you don’t, the fact that during the 0% period so much of your cash has gone to clearing the debt not serving the interest, means that while NatWest has a lower interest rate – even if you left it hanging for 10 years, you’d still owe Barclaycard less than NatWest.

    However it’s worth noting Barclaycard does have a slightly higher minimum payment at the start, which impacts this too. If you look at the amount you’ve paid as well, then after about nine years NatWest does become a slightly better deal than Barclaycard in this.

FIGHT 2: NatWest v 0% borrowing cards (ie, new spending on the card)

If you were planning to use the card to spend on, the top new cardholder 0% deal is Tesco 19 months 0% with no fees followed by 18.9% representative APR after. More options and full help in Top 0% cards.

I went for two variants here, the first, a planned one off big purchase (£1,500) the second, regular monthly spending on the card (a very dangerous thing to do that I’d strongly caution anyone against – using credit cards to fill the gap in your income is never good).

Debt remaining on £1,500 spending repaying fixed £75 a month
After 1 year After 2 years After 3 years After 4 years After 5 years After 6 years After 7 years After 8 years After 9 years After 10 years
Tesco card £600 0 0 0 0 0 0 0 0 0
NatWest £700 0 0 0 0 0 0 0 0 0
£100 spending a month, making only minimum repayments
Tesco card debt left £900 £1,840 £2,756 £3,567 £4,287 £4,924 £5,490 £5,991 £6,435 £6,828
Tesco amount paid £300 £689 £1,381 £2,335 £3,515 £4,896 £6,455 £8,172 £10,028 £12,009
NatWest debt left £1,101 £2,099 £2,984 £3,768 £4,463 £5,080 £5,626 £6,110 £6,539 £6,920
NatWest amount paid £134 £477 £991 £1,661 £2,470 £3,402 £4,443 £5,581 £6,804 £8,103

The results here are split.

  • Tesco smashes NatWest for the one-off £1,500 spend.

    The Tesco card is paid off after 20 months and no interest is paid (as the 20th month is the first one you’re charged interest, but you’re clearing the balance in full so you don’t pay it). The NatWest card is paid off after 22 months. During that time you’ve paid £48 in annual fees and £98 interest, so a total of £146.

  • On £100 a month, NatWest wins in time.

    This is a relatively false scenario as you’d need a huge credit limit; but even so let’s look at it. Tesco is far cheaper in the first 19 months, but even after that NatWest’s minimum repayments are lower than Tesco so even after 10 years you’d have less debt on it.

    That’s why I’ve also added in an ‘amount paid’ row too. When that’s factored in (ie, add debt left to amount paid), NatWest starts to be cheaper after three years.

    Of course you’d be far better off to take Tesco for 19 months then shift the debt to a 0% balance transfer card and get another 0% purchase deal – and better still, not to do it. Yet this does show if you’re going to continually borrow and not pay it off and not manage the cash, NatWest can beat a 0% card.

I did also compare NatWest to the Top all-rounder cards, which give 0% on both purchases and balance transfers. The results there were roughly similar to spending cards – in other words if all the borrowing is upfront with decent repayments NatWest loses, but if you have minimum repayments and keep spending on the card, NatWest over time wins.

The summary

I think NatWest’s adverts are disingenuous and dangerous. The concept would’ve worked five years ago when 0% deals were far shorter than they are now. But certainly with 33 months 0% on balance transfers these are no longer just short-term propositions. To use an advert to mis-portray them as a dangerous product is simply wrong.

That doesn’t mean they always win, it just means there is a choice and different things suit different people. For those who just want to shift the debt, spend and then forget about it without doing anything, stable rate cards have a strong place – and that’s something I’ve always championed. Yet if you are going to do it, NatWest’s card with its annual fee, certainly isn’t the one I’d use.

Do let me know your views below…

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