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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
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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.

  • Thank you for the reply. But aren't I paying more or less the same interest on 2.5% of £100,000, as I am 4% of £25,000? Therefore, I should switch overpayments to the account I'm paying more interest on? – Simon Jun 5 '14 at 10:18
  • Sorry, yes, the difference will always be 1.5% and the variable rate is linked to the Bank of England base rate. – Simon Jun 5 '14 at 10:48
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    @Simon the balances aren't part if the decision. Look at it this way, each 1000 of the 2.5% loan will cost you 25/yr in interest vs 40/yr on the 4% loan. I've had people ask why they should pay their 18% credit card when their 4% mortgage had so much more interest each year. Same answer, it's the rate that matters. – JoeTaxpayer Jun 5 '14 at 11:40
  • Thanks Joe. Is this always the case? eg I should chip away at my loan of £10,000 on an interest rate of 100% before looking at my loan of £1,000,000 at 99%? – Simon Jun 5 '14 at 12:08
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    A very useful site that shows people by example why it is best to pay off the highest interest loan first, even if the dollar cost of a lower-interest loan is larger, is powerpay.org. Everything is shown in dollars, but it is the principle behind what JoeTaxpayer is saying that is important. Don't let any pennies drop; as they say, take care of the pence and the pounds will take care of themselves. – Dilip Sarwate Jun 6 '14 at 18:09

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