Homeowners dream of the day they finally become mortgage free – but should you bring that happy day forward by overpaying your mortgage with savings?
Millions of households are presented with this dilemma as lockdowns leave those with unreduced incomes able to save more than they have been able to for decades. Households saved 29p in every £1 between April and June this year, according to official data.
The answer, on first sight, is straightforward. If the interest rate you are paying on your mortgage is higher than the one you are receiving on your savings, you should use savings to pay down your mortgage.
Should you overpay? Homeowners dream of the day they finally become mortgage free
The gain of cutting your mortgage will more than offset the loss of interest on your savings. With savings rates at near-record lows, it is almost impossible to find one that is higher than your mortgage rate.
Easy access savings accounts pay just 0.23 per cent on average, according to Moneyfacts, while fixed-rate bonds pay just 0.68 per cent. Katie Brain, banking expert at financial information scrutiniser Defaqto, says: ‘With a difference of at least one per cent between savings and mortgage rates, it is definitely a good idea to consider overpaying on your mortgage, provided an emergency savings fund has been established first.’
Yet the equation is more complex than it first appears. There are other points to consider.
1. A savings sum is useful
A savings nest egg can be invaluable if you have a financial emergency – the car or boiler breaks down or you find yourself facing redundancy.
Don’t pay down your mortgage if it means waving goodbye to an emergency fund.
David Hollingworth, loans expert at L&C Mortgages, says: ‘Once you’ve overpaid your mortgage, you can’t easily get it back again.
‘You would need to remortgage or get a further advance with your lender. This process entails everything that goes with getting a new mortgage. It’s possible, but a drawn-out process.’
2. Watch out for fees
Most mortgage providers allow you to overpay up to ten per cent every year without incurring early repayment charges, but charge steep fees beyond that amount. Check your lender’s policy before overpaying.
3. Pay off other debts first
Your mortgage is likely to be one of your lowest-cost debts. Credit card bills, unsecured loans or overdrafts should be paid off first.
4. Consider alternatives
You could pay into your pension instead. Pension payments benefit from tax relief. This means if you pay £80, the Government will top it up with tax relief worth £20. If you are a higher-rate taxpayer, you receive twice the amount of tax relief. If you will not need the money before the age of 55 (or 57 from 2028), putting money in your pension may be more lucrative. If you are already drawing your pension, you can only pay in new sums up to £4,000 a year and benefit from tax relief.
Investing some of the money is another option. But there is no guarantee you would make more from investing than from paying down your mortgage – and you could even lose money.
5. How would you feel?
If debt makes you anxious, the relief of paying it off quickly could make it all worthwhile.
Carla Morris, director of wealth manager Brewin Dolphin, says: ‘For some people, being debt free is important. Other people are less bothered about having manageable debts. If debt causes you anxiety, it may be worth paying off your mortgage sooner, even if you could earn an extra percentage point or two using the money for a different purpose.’