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My wife and I are currently househunting and have, as part of this process, had a preliminary meeting with a mortgage adviser. They asked all the expected questions about finances to see what our monthly payments would be and how much we can afford.

I have a pretty good spreadsheet for calculating monthly payments, stamp duty, necessary deposit etc from the inputs like house price, salary, interest rate and desired term so thought I had a decent handle on this; I had pretty much already decided on a term of 25 years, as this comes out with a nice monthly payment that we can afford (£1,640).

The adviser then threw a spanner in the works by recommending that we actually get a longer (30-year) term (at least for the initial 2-year fixed deal) and then, assuming all our finances are in order, overpay each month to make up the difference from £1,430 back to £1,640.

Is this solid advice or not? Whilst it sounds nice to have the ability to forgo the overpayments each month if our financials change, I'm unable to judge the cost of this convenience because my spreadsheet has no way of taking overpayments into account (I don't really know how they work. Do they effectively reduce the term of the mortgage?).

My wife is suspicious that the mortgage adviser is acting in their own best interest by getting a bigger kickback from the lender for a longer term.

Any help on how to compare these two mortgage situations would be greatly appreciated.


Update: Giving a tl;dr of my question.

Do two mortgage loans with exactly the same interest rate and repaid at exactly the same monthly rate result in the same total cost of the loan, regardless of which 'term' was originally agreed with the lender?

  • 13
    Have you asked the mortgage adviser how their commission is calculated? – GS - Apologise to Monica Apr 12 at 12:22
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    Is the interest rate the same for both terms, if not, what are the rates? Sorry, what does "the initial 2-year fixed deal" mean? Is the rate not fixed for the entire term? – JTP - Apologise to Monica Apr 12 at 12:33
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    What does "at least for the initial 2-year fixed deal" mean? Does this imply that the 30-year is an Adjustable Rate Mortgage? aka variable-rate mortgage or floating-rate mortgage. If you can comfortably afford the 25-year then there is no reason to extend it to 30. – MonkeyZeus Apr 12 at 13:27
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    Most lenders will let you choose whether overpayments are used to reduce the term of the mortgage, or lower the remaining monthly payments. Some also let you borrow back overpayments, so if you use them to lower the monthly required payments you can still keep making the original larger payments, eventually you will get to a point where you have to pay like £1 / month for the remainder of the loan and then you can decide whether to close off the loan early or keep up the teeny tiny payments and retain the flexibility of borrowing back the overpayments. – Vicky Apr 12 at 13:59
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    @R.. no it doesn't. This is a perfectly ordinary situation and the advice is sound. – Tom W Apr 14 at 7:32
56

Two mortgages with the same interest rate and same monthly payment are identical in their total cost and time-to-repayment, regardless of the loan term.

The big caveat here is that the 25-year and 30-year mortgage rates are in fact identical, and that there is no prepayment penalty on the mortgage. So long as that is the case, you can take a 30-year mortgage, overpay the principal to match what you would have paid for the 25-year monthly payments, and have it paid off in 25 years for exactly the same total cost as just taking the 25-year to begin with.

The advantage is that you have additional flexibility to reduce your payment to the 30-year monthly payment if needed. This will of course increase the time-to-repayment to somewhere between 25 and 30 years, but it is preferable to taking a 25-year mortgage and being unable to keep up with the payments.

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    This. Unless there's silly things like payment fees or penalties for paying early/over. – xyious Apr 12 at 15:41
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    Under "silly things": This makes the assumption that the overpayments are going toward the loan principal and not simply "pre-paying" regular mortgage payments for future months. OP needs to make sure that he can overpay on the principal like that. – afrazier Apr 12 at 16:05
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    Adding to @afrazier, my experience is you have to take specific steps to make sure it goes to principal (including a note with the check, or checking a box...) If you use online payment with your bank, this can be inconvenient. Make sure it is convenient enough for you to follow through on before you sign up. – rrauenza Apr 12 at 16:08
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    If there are any difficulties in making payments online to properly apply toward principal, you can make the extra payment in person or by mail with a note just once per year and get almost the same benefit. A mortgage calculator shows that an extra payment toward principal every 12 months for 12 times the monthly difference between a 25-year and a 30-year mortgage gives you a payoff in 25 years + 1 month. The 12x extra payments occur in month 12, 24, 36, etc. The final payment in month 301 is just slightly less than a normal 30-year monthly payment. – MTA Apr 13 at 16:50
  • When I took my mortgage, there was no difference between 20 and 30 year rates and commissions. The 40 year one was more expensive. Just an anecdote, but shows that banks happen to be lazy enough to reuse rates over some length span. – Agent_L Apr 13 at 17:46
17

Of course the total payments on the 30 year term will be more than the 25. Making such a comparison can lead to a foolish choice. Let me offer an example.

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First, this scenario is not a likely one, at least it doesn't represent two offers from the same bank. But let's assume it was 2 offers from different banks. The first bank only give out 25 year loans, and the second, only 30. Of course, you look and see the payment for the 30 is a bit lower, as is the rate. But, the total payments are 16,000 higher. If you use 'total cost' as a criteria, you've made a bad decision. By taking the lower rate, 30 yr loan, and making the same payment as the 25 year loan, i.e. 2639, you would pay it off in 23 years, and actually save 63,000. The mistake is the 'total payments' ignores the time value of money.

That said, I would choose the 30 year term without hesitation if the rates were identical. The first year or two in a house brings unexpected expenses, and it's better to keep that flexibility. Better to stretch out a home loan, literally the lowest rate loan one will ever have, and avoid the higher rate loans that come with credit card or store purchases. (In the US) a mortgage can be prepaid, so if the day after you get the loan you decide that 25 was really the right choice, you simply make the payment amount for the shorter term, and it will amortize the loan down to that. You can also take your time to decide. Move in, set up your home, and increase the payments after the first year or two. If you get decent raises, spend 1/3, save 1/3, and add 1/3 to the mortgage payment, if you wish. That will reduce the term even further.

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    Only suggestion I'd propose for this answer would be that a shorter term has a benefit in that it 'forces' you to make those over-payments made possible in the longer term mortgage. For someone who feels they may need such external motivation, that might outweigh the loss of flexibility. Similar to how one of the financial offshoot 'benefits' of buying a house is simply that it forces you to save money being paid against the principal portion of your mortgage each month. – Grade 'Eh' Bacon Apr 12 at 13:19
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    A 30 year loan (at the same interest rate) as an N-year loan, will be paid off in the same exact time as the N-year loan if that N-year payment is applied. – JTP - Apologise to Monica Apr 12 at 13:37
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    @JoeTaxpayer A 30 year loan (at the same interest rate) as an N-year loan, will be paid off in the same exact time as the N-year loan if that N-year payment is applied Thank you, this simple fact helps my understanding a lot! – Richiban Apr 12 at 13:40
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    You won't get (and wouldn't want) a fixed rate for 25-30 years in the UK. It's not how things typically work here. Please don't assume that US experiences are universal. – Vicky Apr 12 at 13:56
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    @JoeTaxpayer typically then UK mortgages are offered with a fixed rate for the first few years (usually 2,3 or 5 years) which then switches to a variable rate for the remaining term. During the fixed period there is usually a penalty for overpayments beyond a limit set by the bank, afterwards then there is usually no penalty. Its very common, at the end of the fixed period, to remortgage with the same or another provider. – Tom Revell Apr 12 at 14:08
11

A simple decision tree

Here is a simple decision tree that should work in almost all cases.

1. What is most important for me?

  • Financial flexibility? --> Take the longest term
  • Firm motivation to pay faster than needed? --> Take the shortest term
  • Flexibilty as long as it does not really cost money --> Go to 2

2. Which interest rate is higher? (note, this is really about the RATE, not about the amount over the total runtime without extra payments because I will assume dicipline on your side to pay off on your planned schedule)

  • The 30 year loan has a higher annual interest % --> Flexibility costs money, there is no free lunch!
  • The 25 year loan has a higher annual interest % --> Assuming you pay as planned, you will actually save money by paying the 30 year loan in 25 years. Do check that you are allowed to make sufficient extra payments against the principal without penalties. Key assumption here is that interst is calculated each year based on the actual open principal.

I had a similar dilemma as you before, and based on the terms available to me it was in fact cheapest to get a 30 year loan and pay it off in an accelerated rate.

The only contractual 'drawback' being that the amount I could pay off each year without penalties was slightly lower. But assuming you are allowed to pay off 10% of the principal each year, those constraints only hurt if you end up paying the house off in less than 10 years or so.

7

Commissions are a red herring in this case. It’s not how much he earns that matters to you - it’s how much you need to pay overall, and whether you value the flexibility of dropping your monthly payment from time to time.

You haven’t provided enough information for us to calculate it, but the question to ask your advisor is what your total payment will be, assuming you pay £1640 per month. Make sure they include all fees, charges, early payment penalties if any, and everything else.

Get this total figure for both the 25 year and 30 year terms. You can then compare them to see which works out better. If the 30 year term is more expensive, consider whether the flexibility is worth the extra. If the 30 year total isn’t more expensive, that’s even better for you.

  • 2
    "If the 30 year term is more expensive" - sorry, no. That math results in a potential bad decision. Please see the beginning of my answer. – JTP - Apologise to Monica Apr 12 at 13:05
  • @JoeTaxpayer If the repayments are identical, the time value of money will be the same both ways. It then comes down to fees and charges, particularly for paying off the mortgage early. I accept that the first two years are structured to not allow overpayment, but that can be tweaked by borrowing slightly less to compensate, so that at the start of the third year, both scenarios are on even footing. The one thing that can make a big difference is the interest rate applied to each case. – Lawrence Apr 12 at 13:17
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    Understood. My concern is that the way this was phrased, simply totaling payments may lead to a false conclusion. – JTP - Apologise to Monica Apr 12 at 13:20
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    @Joe Note that when I say “total cost” in my answer, I’m talking about the case where the monthly repayment is £1640 in both scenarios. If you’re talking about using different monthly repayments in each case (namely, the minimums), that misses the OP’s intention. – Lawrence Apr 12 at 13:26
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    @Joe Our comments crossed. Thanks for your note. – Lawrence Apr 12 at 13:27
4

I opted for this twice, for two, two-year fixed terms, on my old property, at the advice of my mortgage adviser.

The reasoning was sound - if for any reason my income drops, I can reduce my payments to the minimum that is feasible with no penalty and with no negotiation with the mortgage lender required.

I can choose to overpay when I do have enough income, and this overpayment is not subject to interest deductions and is taken out of the principal. This makes its impact felt when the fixed rate ends and the mortgage is up for renewal, as it has reduced the Loan-to-Value figure below what would otherwise have been expected for a thirty year term.

Finally, assuming the adviser is not unscrupulous, they have a legal responsibility not to give one advice that is unsuitable, and so based on your and my experience of being advised to do it, I can assume that this strategy has a certain authoritativeness.

2

Short answer: yes, I think your adviser is pretty much right; and you're right that the total amount you pay doesn't change if you vary the mortgage term.  However, it can't vary too much, or penalties kick in.

I looked into this when I got a mortgage a couple of years ago.  My mortgage guy didn't push a longer term, but I worked out the detail, and came to the same conclusion you did: if you have a repayment mortgage that you're going to pay it off in N years by paying X/month, then you'll pay exactly the same amount if the term written on the mortgage is a bit longer than N. (I.e. there's no direct penalty.)

So a longer term gives you flexibility to reduce your payments if needed (down to the level at which it takes the full term to pay off), but if you don't, then you don't lose out.

However, there's a corresponding disadvantage: mortgages tend to have penalties for very large overpayments.  (In my case, if I pay off more than an extra 10% of the value in any year, I incur a charge of something like £6,500.)  So increasing the term restricts your ability to pay it off much earlier.

So when choosing a term, you have to balance:

  • the likelihood of getting into financial difficulty and needing to reduce the payments and take longer to pay it off, against
  • the likelihood of being in a particularly good financial position and wanting to increase payments and pay it off early.

In practice, I think a slightly longer term than you need can be a good idea; but do think through the possibilities, and check it with your adviser.

Finally, you may not need to take an irrevocable decision now.  If you get a fixed-rate mortgage or other deal, then it'll revert to the standard variable rate after 2/3/5 years, which would be a good time to remortgage and get another deal — and (I think) you can then pick a new term anyway.

  • 1
    You can certainly pick a new term when you remortgage. It's a completely new mortgage with no connection with the old one. – Martin Bonner supports Monica Apr 15 at 12:01
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All else being equal, take the 30 year term. Extra flexibility is always a positive. Beware of all the clauses that everyone else has talked about. Get an offset account if you can (an offset account lets you apply savings against the principle for purposes of interest calculation without paying extra directly into the mortgage - these are known by other names in some other countries).

However, there is one thing that nobody seems to have spoken about so far - the fact that regardless of the length of your term you should refinance your mortgage every five years (or sooner).

Banks are a competitive industry. They offer all sorts of discounts to try and draw in customers. Presumably, in five years time your situation will have changed (hopefully for the better). You will have a better credit rating, a higher income and a smaller mortgage. In spite of this, you will be paying a higher rate on your mortgage then than you could be even if it's lower than now. The only way around this is to refinance every few years.

The other advantage of refinancing is that you can either extract equity from the house or, having paid down some of the principle, you can take out a smaller mortgage. Taking out a smaller mortgage (as a percentage of the loan) generally results in lower interest rates.

The reason I bring this up now is that you need to be aware of any exit fees that you may have to pay if you leave the bank. In some countries these are illegal, but in many they're not and the cost of moving away from the bank should be factored in when doing interest rate and mortgage length calculations.

  • I wouldn't make it a hard rule to refinance every 5 years. It is a good idea to research whether refinancing would save you money, and you could do that as frequently as every year if you wanted to. The key issue to be aware of when refinancing is origination fees - they need to be low enough that you will break even (the savings from a lower interest rate will equal or surpass the fixed cost of the origination fees) within your investment horizon (the remainder of the mortgage term or the date you intend to sell the property - whichever is sooner). – CactusCake Apr 15 at 13:06
  • Looks like origination fee appears to be a US term. UK mortgage companies have the same thing, but call them arrangement fees. – CactusCake Apr 15 at 13:22
  • It doesn't take much of an interest rate cut to save you more than the establishment fees (Australian term). I've refinanced three times in the last five years for various reasons. Every single time I got an interest rate cut. The banks love giving you rewards for joining. They also love squeezing every cent out of you once they have you. – Stephen Apr 15 at 23:53
  • No but it does require a rate cut of some amount. While you have experienced lower rates with each of your 3 refinances, that isn't always guaranteed. All I'm saying is that you should check that the rates are indeed lower before executing a plan to refinance every n years. Rates can go in either direction. – CactusCake Apr 16 at 13:29
  • OP is looking at getting a 2 year fix. That means he should be looking at refinancing in.... 2 years. Not 5. – AndyT Apr 16 at 16:13
-2

Just don't mess with the 30-year loan, get what you want.
(This assumes that the rate is the same, if the 25yr rate is lower that is an additional reason to choose the 25 year term)

Do two mortgage loans with exactly the same interest rate and repaid at exactly the same monthly rate result in the same total cost of the loan, regardless of which 'term' was originally agreed with the lender?

Yes, as other answers demonstrated... but, there could be other problems issues that annoy you.

I had a situation (USA not UK) where there was no pre-payment penalty and I was paying a little bit extra. But the company servicing the loan had a policy... if you did not mail your payment coupon filled out to indicate that you wanted the additional amount to go to principal, it would be put into your escrow instead. Because I was paying using an electronic check, they were putting the additional funds into the escrow account.

I had pretty much already decided on a term of 25 years, as this comes out with a nice monthly payment that we can afford.

If you want a 25-year loan... and can afford a 25-year loan... then you should get a 25-year loan.
Take a close look at both estimates, and if your mortgage adviser makes more from the 30-year loan you should find a new mortgage adviser and then get your loan.


It was pointed out in a comment that the UK doesn't have they type of escrow accounts that are typical with almost all home loans in the US. (Thanks for that!) But my answer is unchanged.

My point is: the mortgage owner/servicing agent might make you jump through extra hoops instead of doing what you want them to do (apply the extra amount against the principal).
That extra annoyance will make you wish you had the 25.

OP is capable of spreadsheet-ing out all related expenses, and so shouldn't be worried about needing to make the 30-year payment instead of the 25-year payment.

Any "planner type" person wouldn't ask the question if the reason is, "I might not be able to make the 25-year payment".

The OP is asking to make sure they didn't miss something obvious... and they didn't.

  • 1
    What I did which was quite simple (UK): The mortgage company had a direct debit on my bank account, and I added a standing order to pay more every month. About once a year the mortgage company figured out that I had overpaid and reduced my payments to finish at 25 years, and every time I just increased my standing order accordingly. Just had to go to the bank once a year. – gnasher729 Apr 13 at 22:56
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    This answer does not deserve the -3 rating. It has some really wise info about mortgage companies, never assume your extra payment is automatically going towards your principle. – WetlabStudent Apr 15 at 1:57
  • @gnasher729 I am glad that worked out well for you. My mortgage company cut me a check for the excess escrow amount, which I got back without interest... because escrow accounts don't earn interest... months later. Court costs, of course, would far exceed anything I might get if I sued them over the less than twenty dollars - even though my lawyer costs would have been zero (assuming they'd do it gratis; related to a few of them). – J. Chris Compton Apr 15 at 16:33

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