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Overpaying the mortgage versus saving: what's best?

Overpaying the mortgage can knock year and thousands of pounds off the cost of your mortgage.

 

by Michelle McGagh on Dec 19, 2012 at 13:45

Overpaying the mortgage versus saving: what's best?

Paying down debt before saving is a financial planning ground rule, but does this apply to paying off your biggest debt: your mortgage?

Everyone knows that paying the minimum on the credit card each month will mean that it will take you longer to pay off the debt and you will rack up more interest in the process.

Due to the interest mark-up it is prudent to overpay the minimum in order to try and get the credit card bill back down to zero, and the same applies to the mortgage.

Overpaying the mortgage is an alien concept to many people, who see their monthly mortgage payments as just another bill that goes out each month. However, the mortgage isn’t just another bill, it’s a debt, and the quicker you pay it off the more money you save.

Saving versus overpaying

As the mortgage is considered a monthly outgoing rather than a debt, many people are accumulating savings but still paying the minimum on their mortgage. It’s always a good idea to have some easily accessible money in reserve but is it a false economy to keep saving when the mortgage payments are knocking minimal amounts of the total home loan?

Jason Holmes, director of Lumen Financial Planning in Northern Ireland, said you need to strike a balance between savings and paying your mortgage.

He would not recommend throwing all your savings at your mortgage, but instead keep an emergency fund back to cover any large, unexpected outgoings. Depending on your circumstances, it is recommended that you have three to six months of monthly expenditure saved – so if your monthly bills are £1,000 then you need to have between £3,000 and £6,000 in easily accessible savings.

Holmes said whether you overpay or save depends on your mortgage rate and what interest rate you can achieve on your savings.

If your mortgage rate is higher than what you’d get from your savings then it is better to overpay, but if the situation is reversed and you are benefiting from a savings rate that is higher than your mortgage, then you should save.

‘Lots of clients are paying low interest on their mortgage and can get a better return by saving in the bank,’ said Holmes, adding that everyone will have to judge it against their own personal circumstances as mortgage rates and saving rates will differ.

Benefits of overpaying

Holmes is overpaying his own mortgage and hopes to have the balance cleared in seven years, rather than the full term of 16 years.

‘I am paying off my mortgage. My son is 11 and in seven years he may want to go to university but instead of saving for it I will have paid off my mortgage and will have extra money to help him with living expenses,’ said Holmes.

‘Even if my son doesn’t go to university, it means my mortgage is paid off. You are paying less interest on your mortgage and there is no investment risk – you are just building up equity in your property.’

He added that even a small amount of overpayment can make a large dent in the term of the mortgage and the interest paid.

The average house price in the UK is just below £250,000, if you assume the homeowner has put down a 10% deposit and has a mortgage of £225,000, taken out over a 25-year term and paying 3% interest.

Assuming the interest rate doesn’t change over that time the homeowner will pay £1,067 per month and the total amount paid back, repayment of the loan plus interest, will be £320,093 – that’s £95,093 in interest.

By overpaying £100 per month, the mortgage will be paid off in 21 years and the total repayment falls to £307,350, saving £12,743 in interest.

If the overpayments hit £250 per month, the loan will be paid off in 18 years and cost £293,639 – a saving in interest of £26,454.

Free up your money

Holmes said that many people are worried about using their savings to pay off the mortgage because ‘they think they will never be able to save that amount again’ but what they need to remember is they will have more spare cash once the mortgage is repaid.

Just as Holmes wants to use the money freed up by ditching his mortgage to help his son if he chooses to go to university, releasing yourself from the burden of a mortgage can help you achieve more.

‘Mentally, paying off the mortgage gives people a freedom, especially if you have a spouse who wants to reduce the amount they work. Getting rid of the mortgage frees people up to decide what they want to do with their lives,’ said Holmes.

28 comments so far. Why not have your say?

David Chapman

Dec 19, 2012 at 14:35

In my view it is never wrong to pay off debt - particulary in these difficult times - but as has been said, give yourself a cushion first.

Even if debt is at a low rate, overpayments take out chunks of the capital and will clear the debt all the sooner.

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Richard-S

Dec 19, 2012 at 15:19

I can see the benefit of overpayment and agree with the author and David, but what is the real value of £12743 in 21 years time. It will of course depend on the rate of inflation between now and then, but all we know is that its real purchasing power will be a lot less than it is nowbe paying the debt with cheap money. It could be that an individual could get more benefit from spending the money now rather than in a couple of decades time.

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Anonymous 1 needed this 'off the record'

Dec 19, 2012 at 15:31

The article is, to my reading another poos mixture of the 'not always true' and lack of consideration.

Got the right Credit card - and paying it off is a mistake - use the 12 months no interest on purchases - put the money in a savings account)

Similarly, with a cheap 0% interest balance transfer - you've probably already paid 3% as an up-front fee, so for 18 months loan that's like a 2% interest charge if you pay it back at the end, and if you pay it back in 3 months, it's like 12% interest.

So - on to mortgages

What 'type' have you got, are you allowed to pay extra without a surcharge being applied.

Does it have an associated offset account

Can you draw-down any excess payments you have made, or take a payment holiday until the earlier excess payments have been made.

Can you get more (after tax) from having your excess cash in a savings acount than you would have saved by reducing the mortgage.

Now, BoE rates have been low for a long while, BUT if you put savings in a fixed term account at - say 4% gross, less 25% tax = 3% so you'd be better off saving than paying off a BoE+2% mortgage

But if the BoE rate goes up 1% you'll be unhappy about the fixed termand rate.

Consider a floating savings rate BoE + 3.5% that's better than the mortgage cost (4% less tax less BoE+2% = 1/2% extra.)

Now what if the BoE hits 1.5%

(1.5%+3.5%) less 25% tax = 3.75%, mortgage = 3.5% still better by 1/4%)

Now what if the BoE hits 3%

(3%+3.5%) less 25% tax = 5.75%, mortgage = 6% Oops!)

And - what if you're a higher-rate taxpayer, or the government change the basic tax rate, or reduce relief.

And that's without considering the effect of having savings in the bank if you become unemployed, or qualify for 'benefits'

And - for those considering Equity Release - consider what a capital sum in the bank will do for your benefits status.

Also - a minor cost, but be careful about actually paying-off the mortgage -

Closure fees, return of Title fees, and then you have to have the title kept securely - Then if you want to borrow a bit more perhaps to fix the roof properly. That will be a full credit check, verify your ability to repay before you are too old for a mortgage (at 65?), valuation and other fees.

What - 'let-go' at 55 and not yet getting a pension, so why are you wasting time)

Yes - paying it off could cost you over £1000, and you may not be able to get a small, long-term loan without paying - say £600 in fees.

So - it's consider the effect of having savings, and the associated costs of what you do with them, as well as the long term possibilities of doing 'whatever' with that savings.

Me - I paid the extra up-front fee to get a overpayment-drawdown-holiday facility with the mortgage, and a low increment on the BoE rate.

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snoekie

Dec 19, 2012 at 15:52

When mortgage rates went down, in the 90s, from 15%, instead of reducing the payments to the lender I increased the monthly payment, and ten years later, with the aid of the whole life policy I was advised to take out on a previous mortgage - cashing it in, I paid off the mortgage entirely.

Be sure to make sure that the lender actually, annually, applies the excess to the capital, account otherwise it sits on the current account showing a credit on the the payments to be made. That means that less interest accrues, so the amount being paid off actually increases, annually, without additional increases, if there is a pay rise (I would recommend that a proportion of the pay rise is added to the amount you are paying the lender).

But then in those days, of the dim and distant past, mortgages were a lot smaller.

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Anonymous 1 needed this 'off the record'

Dec 19, 2012 at 16:21

@snoekie

Yes - another consideration;

Before paying more, also check when the additional payment will be applied to the account and reduce the debt and interest charged.

Start of, or end of, or a particular day of the month, quarter, or in the case of my parents mortgage - 1st weekday after the 3rd of Jan, with the following years interest calculated on the balance as at the weekday after that.

So paying extra on the 7th Jan wouldn't help until the next year.

Not a lot of difference when the majority of the payment is for the interest on the large outstanding debt.

But - consider the last year - say

6% interest on £5000 = £300, so 12 payments of £475

You pay the gradually increased amount of £700 a month so that's £4900 by July, and only £400 due in August.

Wrong, you are required to make 12 monthly payments of at least £475.

Pay just £400 and you are in default

and the interest of £300 was actually for a loan averaging £2500 for 7 months

which gives an APR of (300*12) /(2500*7) or - about 20.5%

and the extra £75 can go towards the closure and early closure charges.

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Skint

Dec 19, 2012 at 16:44

Before my wife and I bought a property my aim was to pay cash for our first house and have no mortgage. As it happened we decided to get a nicer house than we had the funds for and we ended up with a mortgage, albeit a small one.

With 82% equity our interest rate from memory is fairly low at 2.29% and monthly payments work out to approximately the same amount as the council tax (£219). Even though the amount is trivial in comparison to the given example my top priority is to have the mortgage paid off as soon as possible and made sure there are no penalties for early completion or overpayment when we took our mortgage out.

As I see it debt is debt no matter what name it comes under and you are better off without it. If you hit hard times having no mortgage is one less thing to worry about. I find comfort in the fact either of us could become out of work and the other could easily afford to pay the bills.

I would agree that having a buffer of savings in some form is a sound plan. I use the savings for my next car as the emergency buffer, never had to use it so far but always know if I get an unexpected large bill it is available.

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snoekie

Dec 19, 2012 at 21:05

Anon 1, you have a point.

Agreed that there are pay off charges if you pay a lump sum. So leave a small balance on the mortgage, and let the monthly payments pay that off in a few months, So when there is a nil balance, all that is required is the clearance of the mortgage, maybe £100 (even that is a rip off - refer that on to the ombudsman as the payment should be a 'clerical' charge, maybe £25) otherwise there is a clog on the equity of redemption, and illegal in law.

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Anthony O' Grady

Dec 19, 2012 at 21:07

We cleared our mortgage 4 years ago in our mid 40's and it remains the best thing we have ever done. I'm not interested in the number crunching. Freeing oneself of all one's debts is just a great feeling. Just nice to look at the old place and say 'this really is mine'. If some obsessive number cruncher pulls me aside in ten years time and tells me that I would have been considerably better off doing it another way, I don't really care.

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Anthony O' Grady

Dec 19, 2012 at 21:11

PS- I still can't figure out why Scottish Widows Bank charged us an admin fee of £295 as a redemption charge. £295 for pressing a couple of buttons!

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snoekie

Dec 19, 2012 at 21:31

Anthony, an illegal charge, a clog n the equity of redemption, which is illegal. Complain.

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Forestbhoy via mobile

Dec 19, 2012 at 22:35

When you can pay your debts off,pay them. Really agree with anthony on this,did the same, now if money is tight we don't have to worry, if money is ok, we put it away.....just like the old days, eh .......?

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Anonymous 1 needed this 'off the record'

Dec 19, 2012 at 23:39

If being debt free means a lot to you, why take longer doing it than you need to?

By putting my excess money into savings rather than paying off the mortgage I am now in the situation where the interest from the savings cover the interest on the same amount of the mortgage debt, PLUS enough to pay 2 months interest on the remainder of the mortgage.

Yes - I'm (at current rates) looking to have enough extra saved in by the end of the next 5 years to repay the mortgage 5 years earlier than if I had paid that extra direct to the mortgage company.

My handling of the cash and debt is to make the best use of the assets to offset the debts, and iff the mortgage company will allow a small amount to be left owing, and keep the Title deeds for me - at no extra charge, as well as hold open the possibility of extra borrowing without full equity release fees and contract terms - then whould't it be careless not to allow them to do that, and keep the hundred pounds? in a savings account, or maybe as a paid-up life insurance that will pay off the mortgage on my death.

Then again, if you have the money to pay the mortgage off, and owning the home is important enough to you to justify the annual cost of safekeeping the Title deeds, and you know you won't need extra cash to maintain, and insure the property - do pay-off the mortgage.

@Forestbhoy - yes no worry if you have extra to put away, and if no extra to put away, that's just about OK, but what if you don't have enough to live on.

My approach would allow me to borrow at mortgage rates with minimum delay, and fees.

Yours would probably take 2 months and cost over £1000 in fees.

Now Anthony is not happy that a 'number cruncher' may tell him he could have done better. Yes I understand that he would not like to be shown to be less apt than he thought he was. But if he has paid off all his debt and is happy, then I hope he remains debt free and as happy.

For me, I'd also not be as happy being told I could have saved years getting to the point of having a nice home and a secure living, as I'd be if I was told earlier how to get to that point years earlier.

I'm not saying that debts should not be paid off.

I am saying consider the best (to you) safe and appropriate use of your available cash.

Or - perhaps, to put it another way,

Don't just believe what your bank employee told you, or what the local press pundit published.

Do the arithmetic that applies to, or could, with appropriate selection, be applied to your situation

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alan thorburn

Dec 20, 2012 at 14:12

Overpaying the mortgage versus investing, that would be a more relevant article as "saving" at today`s rates is silly !

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J Thomas

Dec 20, 2012 at 16:14

I would always advise people to pay off their mortgage first before saving.

I bought my first house in 1982 when I was 19 years old, however even then I hated having a mortgage and worked night and day to pay it off by the time I was 22 years old. Of course it's much easier to do this when your very young with no dependants to support.

In those days you simply walked into the Building Society with a cheque to pay them off, there were no redemption fees of any sort whatsoever.

A few years later the Cheltenham & Gloucester repaid me all the mortgage I'd taken out with them when they demutualised, which was very kind of them.

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Anthony O' Grady

Dec 20, 2012 at 16:30

Blimey, did anonymous 1 drop some acid before posting his last blog?

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Anonymous 1 needed this 'off the record'

Dec 20, 2012 at 17:20

No Anthony,

I was trying to point out to other readers that doing a bit of number crunching can save a lot of money, or speedup the time taken to clear a mortgage.

And indicating that I accept you are entitled to your happiness at "Freeing oneself of all one's debts is just a great feeling. Just nice to look at the old place and say 'this really is mine'."

And that you are also, in my view, allowed to maintain your beliefs as in

" If some obsessive number cruncher pulls me aside in ten years time and tells me that I would have been considerably better off doing it another way, I don't really care."

Now, if you want to take me to task about any specifics in my post, please detail them for an explanation and/or discussion.

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Anthony O' Grady

Dec 20, 2012 at 20:12

Anon 1

I was just joking.

Relax and enjoy your Christmas.

X

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andrew sutherland

Dec 21, 2012 at 11:21

OK, the article has its merits, and obviously means well, but really:

"Lots of clients are paying low interest on their mortgage and can get a better return by saving in the bank,"

Can someone please show me where these savings accounts are?! The majority of people with mortgages are 3 - 4%+, accounts paying that type of interest are long gone, unless you fix in for years.

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Anonymous 1 needed this 'off the record'

Dec 21, 2012 at 12:18

Anthony, I hope that X is you making your mark, and not a indication of a kiss.

Andrew,

Admittedly cheap mortgage rates are not easy to find now - Banks may use BoE as a base rate with a hike, but their lending is really considered on rates nearer to LIBOR

(which is why I couldn't figure out if the fixing at a lower rate had cost, or saved me money!)

So - savings -

Type Money as a keyword into an internet search facility - Google Bing etc.

Moneysavingexpert starts with 3.1% notice ISA and 2.35% instant access

There are current accounts that pay up to 4% if you follow the 'rules'

Pick the right account and get a linked saver account4%, (nationwide 4.75% cash-ISA) You may be able to get up to 8%

Current incomings not up to the Minimum throughput required - consider 2 current accounts and transfer £1000 back and forward between them

Basically, you have to work the system for the best rates, which usually seem to be 1 year bonus's so make a diary date. And always remember you can, put it away at for a fixed term - but 1 withdrawal allowed account @ a good, or a a Bo+rate - and withdraw it all, (closing the account later will be a second withdrawal) if the rate differentials go bad on you , or as a last resort, if you have a suitable mortgage agreement use it to pay off the mortgage.

It's mosty a case of keeping your eyes open as you walk down the banking (high) street, or doing an occasional check on the internet. and being flexible in what you consider, plus requiring flexibility in what you take-up.

And I'm still annoyed that I closed my credit card account (Egg) that paid 45 on credit balances - well saving rates back then were 6%+

And consider the RISK if you forget to transfer - whatever for a month after the bonus ends -

Credit card with Purchases or Borrowing @ 0% - setup a bank account payment to pay it off a week before the 0% rate ends - overpay rather than underpay, 3% loss of bank interest vs 17% charge (for 2 months?)

But saving £20 after tax doesn't compensate taking an hour of work @ £30 loss.

And - never forget (for those with lots of cash to move around) the £85,000 compensation limit is per organisation group, not per bank.

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andrew sutherland

Dec 21, 2012 at 12:30

@Anonymous1

The question was hypothetical, I know how to use a search engine.

Your answer was very facetious.

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Anonymous 1 needed this 'off the record'

Dec 21, 2012 at 13:11

Given that you knew your question was hypothetical, I can see that you would view the fact that I took the bother to make a detailed reply to be extremely facetious.

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snoekie

Dec 21, 2012 at 15:55

Everybody seems to be looking at this short term.

One thing is certain, rates are going to rise and invariably the rate will be higher than a savings account.

So, I remain of the view tht it is better to be paying back more than is being asked because it will reduce the capital sum, and at an accelerating rate the longer you go on.

More to the point if the borrower is younger, it is likely that he/she will want to trade up, so there will also be a saving down the line.

If a problem of income arises, there is slack available by reducing the mortgage payments to the amount required, but as soon as practicable I would again increase the amount being paid to the lender.

There are benefits all around, and it may be beneficial in later years, if health etc is affected requiring a scaling back of work, and perhaps having to take a lesser job paying less, because of ill health.

My view.

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ClothKap2

Dec 22, 2012 at 10:32

Well for a very long time now I've had an offset mrotgage. My current interest rate it 2.5%, and by putting any extra money into a savings account with my mortgage lender I get the best of both. - I don't pay interest on what I have saved, which not only pays more of the capital back each month, but also means I can spend the money I've saved whenever I want.

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Mark Jeffries

Dec 23, 2012 at 12:03

As the article states, it is dependent on the mortgage rate. As the (lucky?) owner of a .49% above base rate tracker mortgage (i.e. .99% for the mathematically inclined), instead of paying the mortgage off in a lump sum, the money can be invested in, for example, a Lloyds tracker account that pays base rate plus 2% and moves with any base rate adjustments.Logically, it doesn't make any sense for me to pay off the mortgage - in fact I should be borrowing more if the lender permits and affordability is there? Granted, there is an emotional factor of clearing debts. It all depends on personal circumstances and attitude.

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Mark via mobile

Dec 23, 2012 at 12:11

Hello all,

I have a life term tracker which is 0.38% above BoE base rate. About 20yrs left on it and about £200k to pay off. We are in early 40's. I'm not sure whether to continue paying extra on mortgage each month or put the extra into a savings plan. My min payment is £799 a month.

Ideas welcomed - thanks in advance!

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James Burn via mobile

Dec 23, 2012 at 16:00

For a lot of people, they would be better off investing the extra money in the stock market than overpaying on a mortgage. The FSA medium value for expected stock returns is 5%, and most people are not paying 5% interest on their mortgage.

Over about 28 years, equities are lower risk than cash deposits (ref Campbell + Viceira based on data 1892 to 1998), and since many people are further than 28 years from retirement, I would say that the argument that it is lower risk to pay off the mortgage doesn't apply.

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Brian Pearson

Dec 24, 2012 at 10:20

Common sense should prevail here. You should pay off the debt which is charging you the most interest. That will in turn free up more money, which you can then use to pay off the debt which is charging you the 2nd biggest interest and so on. All should remember, as I am sure you do, that the higher the interets rate, the more money they take away from you in payments and its gone forever..

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David Phan

Mar 08, 2013 at 15:04

@mark

depends if you can get better return 0.88% net

On an interest only 200k mortgage 0.38+base (.88%) amounts to £1760 in interest

assuming that you have a savings cushion, personally I would pay more money towards the mortgage to reduce capital as years to come when base rate is back to norm, you would have paid a chunk off your mort.

Assuming that you was considering saving in cash, the returns are nominal

Say you decide to save £250pm regular saver @ 3% the first months' accrued interest would be £0.62p Gross, then second month £1.25 gros and so on which is nominal.

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