Mortgage Overpayments Two Accounts

Question

I have a capital & interest repayment mortgage that's split into two. The outstanding balance on the original is approximately £100k on a 2.5% variable interest rate, monthly repayment approx £700. The further advance is approximately £34k on a 4% variable interest rate, monthly repayment approximately £330.The remaining term is approximately 14 years.

If I make overpayments of £800 per month, which loan do I begin to repay first and at what point (if any) does it make it sense to switch the £800 overpayment to the other so I am paying as little interest as possible on outstanding balances. eg £800 per month off 4% until balance is at £10k, then switch overpayment to 2.5% mortgage until £20k remains, then switch back etc. Or do I split the overpayment, eg £400 off each etc.

For clarity the loans are:

• £100,000 at 2.5% (variable), payment is £700 / month
• £34,000 at 4% (variable), payment is £330 / month

Answer 1

Both loans are variable? So the 4% loan will always be 1.5% higher than the current 2.5% loan, correct? If paying off sooner is what you want, pay the higher rate loan first. It's pretty similar to choosing a rate of return, if the two banks I am consider are both guaranteed (by my government, for example) why would I choose to get 2.5% when I can get 4%?

A simple example - I owe 1000 at 4%, 2000 at 3%. Clearly, the 2000 has a higher cost, 60 per year vs 40. But. For a moment, pretend the 2000 is two loans, 1000 each, both at 3%. So, now 3 loans, 1000 4%, 1000 3%, 1000 3%. Now, it's really clear, the 4% should be the priority. In my opinion, one should view money as the annual cost per thousand (i.e. the rate) to avoid confusion. Else, a 2% mortgage suddenly feels more urgent than an 18% credit card.