With interest rates fluctuating and the cost of living remaining a primary concern for many homeowners, a common question arises: is it better to use spare cash to pay off your mortgage early, or should you put it into a savings account?
The "right" answer often depends on your individual circumstances, the rates available, and your long-term financial goals. In this blog, we explore the pros and cons of mortgage overpayments versus saving and answer the most pressing FAQs on the topic.
The basic rule of thumb
Generally speaking, the decision comes down to a simple mathematical comparison. If your mortgage interest rate is higher than the interest rate you can earn on a savings account (after tax), you are usually better off overpaying your mortgage.
Conversely, if you can earn more interest on your savings than you are being charged on your loan, your money is technically working harder for you in the bank.
The benefits of mortgage overpayments
When you make an overpayment, you reduce the capital balance of your loan. Because interest is calculated based on that remaining balance, overpaying reduces the amount of interest you’re charged every month thereafter.
-
Pay off your debt sooner: By reducing the capital, you can shave years off your mortgage term.
-
Save thousands in interest: Over the lifetime of a 25-year mortgage, even small, regular overpayments can result in massive interest savings.
-
Increase your equity: Higher equity can help you access better LTV (Loan to Value) tiers and cheaper interest rates when it comes time to remortgage.
Interested in finding out what kind of results you can expect from overpaying on your mortgage? Try our mortgage overpayments calculator below.
The benefits of saving
While overpaying reduces debt, saving builds an accessible pot of cash. This provides a different kind of financial security.
-
Liquidity: Once you pay money into a mortgage, it is very difficult to get it back out without further borrowing. Savings are available for emergencies, home repairs, or life events.
-
The "Savings Buffer": Most experts recommend having three to six months of essential outgoings in an easy-access account before considering mortgage overpayments.
-
Tax-free wrappers: If you use an ISA, your savings interest is protected from tax, which might make the effective return higher than your mortgage rate.
Things to watch out for
Before you commit your extra cash to your mortgage, there are two crucial factors to check:
-
Early Repayment Charges (ERCs): Most fixed-rate mortgages allow you to overpay by up to 10% of the outstanding balance per year. If you exceed this, you could be hit with a hefty penalty.
-
Savings Tax: If you are a high earner or have significant savings, you may have to pay tax on interest earned above your Personal Savings Allowance, which could make saving less attractive than overpaying.
Should I use an offset mortgage?
If you can’t decide between the two, an offset mortgage might be the solution. This type of product links your savings account to your mortgage. You don't earn interest on your savings, but that same amount is "offset" against your mortgage balance so you don't pay interest on that portion of the debt. This gives you the interest-saving benefits of an overpayment with the flexibility of a savings account.
If you have any questions about your mortgage or want to see if you could save money by remortgaging, get in touch and we’ll refer you to an adviser who can help.