FOOL'S EYE VIEW
The Smart Way To Remortgage

By Jane Mack (TMFJane) & George Row (TMFGrow)
April 27, 2004

The other day someone emailed us to ask how on earth it was possible to 'rate tart' on a regular basis with a repayment mortgage when, in the early years, the monthly repayments went mainly towards the interest costs.

Surely, he said, if you were to remortgage every few years you'd find yourself starting virtually from scratch each time - borrowing almost the same amount of capital on which you would, again, be making mostly interest payments.

The point is, even though most of your monthly payments go on interest, some of your money does go towards paying off the capital. If your interest payments are calculated on a monthly basis, then each month you owe less which means the interest is less. And that means that, each month, more and more of your monthly payment is going towards paying off the capital.

The key to switching to a better rate is to keep your monthly repayments the same and to stick to the original term of the mortgage.

Let's take the case of someone who opts for a repayment mortgage borrowing £100,000 over 25 years at a rate of 5%. It's fixed for three years, interest is calculated monthly and there are no redemption penalties at the end of the three years.

According to London & Country Mortgage Brokers, a mortgage along those lines would mean his monthly payments would be £584.59. In the first month, £407.41 of that payment would go towards paying the interest owed and the remainder, £177.18, would go towards paying off the capital.

So, even after making just one payment, some of the capital would have been paid off even though only by a tiny amount. In month 2, he'd owe slightly less than £100,000 so the interest payment would be slightly less - leaving a bit more to go towards paying off the capital.

Over three years, it'll look like this:

So at the end of three years, our homeowner will be looking for a new mortgage of £93,145.12 spread over 22 years (remember he's sticking to his original term of 25 years).

Let's say he manages to find one that only charges an interest rate of 4% - this time, it's discounted for three years with no tie-ins at the end of the three years. His interest payments will be quite a bit less each month because he's only being charged 4% and, of course, he's borrowed less even though it's over a shorter term.

Crucially, he continues to make payments of £584.59 a month. After all, he's been able to afford those monthly repayments for the previous three years and his aim is simply to borrow the money more cheaply - not to reduce the amount he's handing over to the lender each month. 

So, over the next three years of his mortgage term, his payments will look like this (the numbers in brackets show the interest and balances if he stays with his original lender at 5%):

On the lower interest rate, as he's still paying the same amount each month and less of his payment is going towards the interest, he's gradually paying off more and more capital. After three years he'll have saved himself nearly £3,000.

Even if the best rate he can get for the rest of the mortgage term is 4% he will still have saved money. In fact, he'll find the mortgage will be paid off after only 21 years and 10 months rather than original 25 years which will save him 38 monthly payments of £584.59 ie: £22,214! Even allowing for recent levels of inflation that would still be worth well over £10,000 at today's prices

Admittedly, you have to remember that there are usually some costs involved with switching a mortgage - legal and valuation fees for example - and you need to take these into account. But, particularly in the early years of the mortgage when interest payments are so high, it can definitely pay to be a 'rate tart'.

Find out more about Mortgages and why It Pays To Be A Rate Tart.