Finding the chase and cutting to it

I hope you are well.

I have wiled away my hours not smelling the flowers but wanted to capture the fact here and share my learnings with you.

Nuh?

A couple of big changes are coming our way: our 18 year old will be leaving home and along with that gaining of responsibility we lose the school fees we are paying.

So, what should we do with the windfall?  It’s tempting to live the life of Riley, but what is the best way to make the money work for us?

We still have a mortgage and as my dad always says, settle your debts before doing anything else.  It is pointless to have investments, however safe, if you are paying interest on a debt.  That is even more true at the moment as interest rates are low – while the debt isn’t growing, ensure you can pay it off.

We do have a fixed rate of interest, so we can only pay off 20% a year.  That needs to be born in mind – but yet again, the more we pay off now, the cheaper the debt becomes as it is subject to compound interest.

I did that yonks ago in school.  So what?

While I am paying off the mortgage, the bank are growing the mortgage, in our case daily.  Let’s say the mortgage is £10,000 for ease of sums.  I pay off £1,100 a month but the bank is charging 1.5% a month.

Month	Amount left on loan	Amount paid off	Amount the back charges in interest this month
1	£10,000.00	£1,100.00	£150.00
2	£9,050.00	£1,100.00	£135.75
3	£8,085.75	£1,100.00	£121.29
4	£7,107.04	£1,100.00	£106.61
5	£6,113.64	£1,100.00	£91.70
6	£5,105.35	£1,100.00	£76.58
7	£4,081.93	£1,100.00	£61.23
8	£3,043.16	£1,100.00	£45.65
9	£1,988.80	£1,100.00	£29.83
10	£918.63	£932.41	£13.78

Effectively, you aren’t getting the chance to pay reduce the principal by £1,100 each month as the debt is still growing and it’s growing more in the early stages of the debt than towards the end.  This is called compound interest and in our example above, while we’ve borrowed £10,000, we pay back £10,832.41.

So we’re paying £832.41 in interest.

In this case, our effective interest rate is 0.79%.  If the loan was over a longer period, say 24 months, the AER would effectively double as the number of interest payments would grow and hence the amount it would cost to settle the debt:

Month	Amount left on loan	Amount paid off	Amount the back charges in interest this month
1	£10,000.00	£506.00	£150.00
2	£9,644.00	£506.00	£144.66
3	£9,282.66	£506.00	£139.24
4	£8,915.90	£506.00	£133.74
5	£8,543.64	£506.00	£128.15
6	£8,165.79	£506.00	£122.49
7	£7,782.28	£506.00	£116.73
8	£7,393.01	£506.00	£110.90
9	£6,997.91	£506.00	£104.97
10	£6,596.88	£506.00	£98.95
11	£6,189.83	£506.00	£92.85
12	£5,776.68	£506.00	£86.65
13	£5,357.33	£506.00	£80.36
14	£4,931.69	£506.00	£73.98
15	£4,499.66	£506.00	£67.49
16	£4,061.16	£506.00	£60.92
17	£3,616.08	£506.00	£54.24
18	£3,164.32	£506.00	£47.46
19	£2,705.78	£506.00	£40.59
20	£2,240.37	£506.00	£33.61
21	£1,767.97	£506.00	£26.52
22	£1,288.49	£506.00	£19.33
23	£801.82	£506.00	£12.03
24	£307.85	£307.85	£0.00

In this case interest amount is £1,945.85 which is significantly more than twice the interest and you can get a feel for that as the amount we’re paying back each month is a bit more than half the amount last time.  As this is over a longer time, the AER is 0.7435%.  The interest looks better but you are paying much more for the loan!

You’ve got me hooked, so?

So, if we do the same for the mortgate, the more you pay off when you first have the loan, the better your total repayment is. If you have a mortgage for £180,000 over 25 years your repayments are likely to be £785 a month with an interest rate of 2.25%.  Over 25 years that equals a whopping £235,500 or an interest charge of £55,500.

If you pay the mortgage off more than £785 a month, you will not only save interest but settle the debt quicker.

Doubling your payment, saves more than half the interest while halving the term of the debt.

As I said, you need to be aware of the penalties if you do and work within those limits.  But that’s the approach we’re looking to take.  Doing this in an excel spreadsheet took me nearly 3 hours looking at different amounts of monthly payment.

What I should have done is a simple app – in a couple of hours I could have done something much more usable and I could share it with others.

So that’s what I’ll be doing later today.