historical overpayment on variable mortgage

Sattwa69

Hello,
I'm in the lucky position to have been paying a bit extra off my mortgage for the last few years. Top of the head the amount due is currently about €500 a month and I've been putting in €600. My 'understanding' is that the extra €100 has been going off the principle and has not been used in the same way as the actual mortgage payment (ie. part interest part capital).
A buddy of mine recently alerted me to the fact that he discovered his bank had NOT been taking all the OVERPAYMENT off the capital, they had been splitting it.
I am interested in now checking if this is so in my case too.
Can anyone advise how I might approach this exercise as I'm not sure where/how to start ?

thank you in advance

phormium

Your mortgage is one running amount including capital and interest, there are not two separate accounts so any amount paid in comes off the total which includes capital and interest. Its hard to write an explanation, would be much easier if I could put you in front of banks computer screen and show you the account but anyway here goes- lets say you borrow 100,000 and your repayments are 800 a month @ 6%. Month 1 your balance is 100,000 + interest of 500, 100,500 - you pay off 800 so your balance heading into month 2 is 99,700, then interest is added again of 498.50, you owe 100, 198, then you pay 800 and balance at start of month 3 is 99,938 and so on and so forth.

So any money paid in comes off the total balance at that time, capital and interest, but that reduction in turn reduces the amount of interest being charged in the following month. It is almost always worth making extra payments.

This applies to regular monthly overpayments, a one off lump sum overpayment can be applied directly to the balance but again that balance is made up of capital and interest and not just capital.

This is a very simplified example with made up figures, the systems of banks may differ slightly, some will not 'officially' apply the overpayment to the account unless it reaches a certain percentage of original loan e.g. 5%. It shows as a credit on your account as though you had prepaid your repayments, overall this doesn't matter to you as you are still saving interest, it just means you couldn't use the overpayment to reduce the term or the repayment amount until it reaches that percentage but overall you still save.

Again banks differ in systems but this the one that applied where I worked, a major lending bank so cant be too different to the rest.

Sattwa69

Phormium,
thank you, this is very helpful.
My understanding is that, at the time I took out the mortgage with BOI (years ago !) I asked about overpayments (lumpsum or regular), and was advised that any overpayment comes 'directly off the capital amount outstanding'. Finding that written down might be difficult at this point, but notwithstanding you are saying that its all amalgamated anyway ?
How then does it work that the ratio of capital to interest changes as the total amount decreases, if its just taken as a % of the decreasing balance ?

phormium

The ratio changes as the total balance reduces each months, because the balance is reducing then the interest charged each month is reducing until it gets to the stage where there is very little interest being paid back and mainly capital. In theory if rates never changed then your repayment would remain the same for the full term of the mortgage, it would just be the ratio of it that was interest and capital that would change. Again this is where the confusion arises as that makes it sound like they are two separate payments when they are not, there is just one mortgage account. There is a chart in the linked thread below that shows the reduction and split over the years of a mortgage -again no real split of accounts, just an illustration -http://www.askaboutmoney.com/showthread.php?t=152979