With interest rates on savings accounts at very low levels, putting any spare cash into mortgage payments can be a really good idea that can save a borrower thousands of pounds in interest payments.
In this article about paying your mortgage, as opposed to saving, we shall examine:
- Whether paying off a mortgage earlier is a good idea
- What kind of overpay arrangements mortgages can have
- Things that can happen when you overpay
- Why clearing outstanding debt first is a good idea
- Why an emergency fund is good to have before committing
- Mortgages can have flexible features
- Whether investing money is better than saving
Is paying off your mortgage earlier a good idea?
If the circumstances are right, then paying money off a mortgage can be a good idea. The huge investment that has been undertaken in the form of a mortgage will be paid off more quickly. The amount that is overpaid will not have interest charged and the money that is saved on interest is often a higher amount that could be saved if the money were to be deposited in a savings account.
By overpaying a mortgage, the same amount as the current mortgage rate can be gained as if this were the savings rate. If you had a 3% mortgage then the interest on your savings account would have to match this. If your personal savings allowance had been already used, then an even higher rate would be needed in order to match the mortgage rate. People who are in the higher tax bracket would need to earn 5% interest in order to match the savings.
Many mortgages have a 10% overpay per year arrangement
When a mortgage is still in its introductory fixed, tracker or discount period, most lenders allow the borrower to pay off 10% of the outstanding balance per year. When that period has passed, most mortgages are paid at the lenders standard variable rate. With this kind of deal, usually the borrower can overpay by as much as they choose but it can sometimes be better to look for a remortgaging deal as these rates can work out expensive.
What happens when you overpay?
Fees for overpaying differ between lenders but are usually between 1 and 5% of the amount overpaid, but tend to be lower the closer you are to the end of the fixed discount period. Lenders will differ in their overpayment deals. Many fixed rate 5 year deals will charge the same percentage on the overpay that equals the amount of years left on the mortgage.
Fees for overpaying differ between lenders but are usually between 1% and 5% of the amount overpaid.
For example, on a 100,000 pound mortgage with a 5 year fixed deal, if 15,000 were overpaid then the extra 5,000 that was over the 10,000 overpay deal would have a 3% penalty. This would equate To 150 pounds. Deals vary, so they must always be carefully checked. The reason for these penalties is that lenders have betted on the borrower staying with them after the fixed rate period and have budgeted for a certain amount of profit. When the mortgage is overpaid then they earn less.
Before overpaying your mortgage clear expensive debt
Other debts such as credit cards and high interest personal loans should be cleared off first as they have much higher interest rates. By reducing any high balances on credit cards you will stop the huge repayments that can be as high as 17.99% in some cases. Some personal loans that were taken out before 2011 may not be allowed to be overpaid. The standard rule when clearing debts is to always try and pay off the debt with the highest interest rate first.
If you had 1000 pounds of outstanding debt on a standard credit card, the amount of interest that would be incurred over a year would be 180 pounds. If you put the same amount of money in a top savings account the amount of interest that you would make over the year would be 10 pounds. By paying off the credit card you would have saved 170 pounds more than you would have if you had kept the savings in an account.
So what have we learned so far?
- Paying off a mortgage early will depend on the kind of mortgage that you have
- Savings accounts have the lowest interest rates ever, so a mortgage rate is often much better
- The mortgage needs to have an overpay arrangement to make it worth it
- Fees can be from 1 to 5%
- Sometimes it can be better to remortgage
- Overpaying your mortgage can incur interest penalties
- Other debts with very high interest rates should be cleared first before overpaying a mortgage
Make sure that you have an emergency fund before you overpay
Before committing all your spare cash to mortgage repayments it is essential to have enough cash on hand to cope with any emergencies that may crop up. Being made redundant or having a boiler break down could send you back into debt by having to take out a payday loan or another kind. If you do not manage to meet your monthly mortgage payments due to unforeseen circumstances, your lender will not take into account the amount that has been overpaid and will still charge penalties.
If you became made redundant, or had some other form of emergency it would be a great relief to have between 3 and 6 months worth of monthly outgoings in a high interest savings account. Knowing that you had this pillow to fall back on to be able to function until you could get yourself sorted again would be a big help. Once the money has been overpaid then it will be unavailable. It is better to sacrifice some interest savings in order to stay afloat.
Mortgage overpayment questions:
If you can get a higher return rate on your savings compared to your mortgage rates, then you are better off saving money rather than overpaying your mortgage. However, if your mortgage interest rate is higher than your savings returns, then it would benefit you to overpay your mortgage.
You should generally choose to overpay your mortgage if you have the choice to do so. Making overpayments when this suits you financially allows you the flexibility to cut back on overpayments when you are unable to make them. If, on the other hand, you choose to decrease the term of your mortgage, you may start to struggle if you face changes to your income. Being on a contract with higher monthly payments would not allow you to have the same flexibility as making overpayments when this is convenient for you.
If you are able to overpay your mortgage, you should contact your lender directly and speak to them about this. Your lender will inform you if overpayments are allowed as part of your current contract. Your lender may also present with one of two choices once you have made your overpayment. One option would typically be to reduce the next month’s payment by the amount that you overpaid. This would not, however, help you financially in the long term. The second, most sensible option you would be offered is to reduce the mortgage term. In this manner, you would be able to make long term savings on your mortgage repayments.
There are mortgages with flexible features
There are mortgages available that have flexible features which allow people to put all their savings into the mortgage and then borrow it back should they need to, without paying penalties. This kind of mortgage can be used like a high interest savings account but they usually have higher interest rates and with the introduction of the recent personal savings allowance, they are not always better.
Is investing money in stocks and shares better than saving?
By investing money in stocks and shares, over the long term the financial gains can be high. On the other hand this is a risk related investment, so you could also lose your money. The higher the interest rate is, the higher the risk. There are no guarantees when you choose to invest in this way. A good investment can see high returns of 10% over the long term.
The stock market is volatile and has its ups and downs. The point is to leave the money in for a longer period in order to ride out the storms. In the long term the markets usually recover and financial gains can be made. Financial advice should always be sought before deciding to invest in the markets as it is very difficult to choose what to invest in. By putting your cash into your mortgage, you will have a safe return for your money.
So what can we conclude about paying off your mortgage as opposed to saving money in a savings account?
When a borrower’s mortgage rate is higher than a savings account rate then it is definitely more profitable to put your savings into your home. This does apply when there are no overpayment penalties that have to be paid. Before doing this it is essential that any high interest outstanding debt has been paid off before hand. An emergency fund is always needed before putting money into a mortgage as lenders do not take overpay into account and still charge penalties.
Investing money in stocks and shares can have a higher yield but is always risky, where as if the money is put into mortgage repayments it is safe. Just the feeling of paying off such a huge debt more quickly can relieve stress for many people and give them a great sense of achievement. Independent financial advice should always be sought and mortgage terms carefully considered before any big decisions are made.