Should I overpay my mortgage or save?
Making the right financial decision: Mortgage overpayments vs saving
Mortgage overpayments vs saving
Paying off your mortgage early sounds like the obvious choice, but is it the best financial move? On the one hand, bringing down your mortgage debt sooner not only brings peace of mind but could save you a significant amount of interest payments.
On the other hand, building a healthy savings account is a vital safety net that every household should aspire to, not to mention the possible investment opportunities that savings can open up.
So, is it better to overpay your mortgage or save your money? There’s no right or wrong answer, as the choice depends on your circumstances. To help you make an informed decision, we’ve explored the pros and cons of making overpayments on your mortgage vs saving.
The case for overpaying a mortgage
One of the most compelling reasons to overpay your mortgage is the reduction in interest over the life of the loan. The quicker you can pay off the capital, the less interest you'll pay. Overpaying your mortgage can also reduce your loan length, helping you become debt-free sooner.
Should I overpay my mortgage when inflation is high?
Generally speaking, overpaying your mortgage is always a good idea. When inflation is high, paying more towards your mortgage means the higher rate of interest is applied to a smaller debt, therefore making it more affordable overall.
However, if savings interest rates are also on the rise, this can create a logical argument for saving instead of overpaying.
When you should save
Firstly, how does interest work on a savings account? ou are rewarded with a percentage of your savings balance. So if you save £100 on a 3% interest rate account, you receive £3 in interest for the year.
On the other hand, interest on a mortgage is calculated for the mortgage term (an average of 32 years). If your mortgage interest rate was the same as your savings - at 3% - you would be charged more interest over the mortgage term.
If you have a lower interest rate on your mortgage than on your savings account (for example, your mortgage is 3% and your savings is 6%), it makes financial sense to save with the higher interest rate savings account rather than overpay your mortgage. This way, you’ll benefit from accrued interest while your savings rate is higher than your mortgage. You can always use that money (plus a little extra from interest) to arrange a one-off lump sum mortgage overpayment later.
When you should overpay
If your mortgage interest rate is similar to (or more than) your savings interest rate, it’s recommended that you overpay your mortgage instead. This is because the interest you’ll earn from savings would be less than the interest you’re paying on your mortgage. In short, you’ll save more money long-term by overpaying than you would by saving.
Is overpaying a mortgage worth it?
Yes, overpaying your mortgage is definitely worth it. Overpayments reduce capital, which means less interest.
So, for example, if you make a £1000 overpayment on a mortgage with a 5% interest rate, then you’re saving £50 in interest every year. Considering a mortgage can span 30 years, regular overpayments could save you £1000s in interest over those years.
Is it cheaper to overpay a mortgage or reduce the term?
Reducing the term and overpaying provide the same results, it’s the flexibility that differs.
Reducing the term means shortening the amount of time you have to pay off your mortgage. This can be a good option if you have the financial means to make higher monthly payments. By paying more each month, you'll be able to pay off the loan faster and save on interest in the long run.
However, it's important to note that this strategy is less flexible than making overpayments on a mortgage. Once you commit to a shorter term, you'll need to make those higher payments for the duration of the loan.
Overpaying, however, enables more flexibility in your payment schedule. Instead of committing to a shorter term, you can make extra payments as and when you're able to. This can help you pay off the loan faster without locking you into a rigid payment plan. Additionally, if you experience any financial setbacks in the future, you can ease up on your overpayments without penalty.
Is it better to overpay a mortgage monthly or annually?
When it comes to overpaying a mortgage monthly or annually, neither is ‘better’. Making a £1200 one-off overpayment each year saves the same amount of interest as overpaying £100 per month.
The main advantage of regular monthly overpayments is that it's more predictable. You can simply factor the extra cost into your monthly budget. If you decide you can't afford your overpayments, you can reduce or stop them at any time and go back to your original monthly mortgage repayment.
How to overpay your mortgage
If you choose to make overpayments on your mortgage you can simply do so by contacting your lender and making the overpayment directly with them. This will be treated as a one-off payment and won’t affect your regular monthly mortgage repayments. If your mortgage is with us, you can find details of how to make payments here.
How much to overpay your mortgage
When you take on a mortgage, your obligation is the monthly direct debit you agreed with your lender when your mortgage started. There are exceptions to this; for instance if you have a flexible mortgage, you may have the option to underpay or take a mortgage holiday. You can read more on flexible mortgages here.
But when it comes to overpaying, how much you overpay your mortgage is completely up to you. It does, however, depend on the kind of mortgage you have. For most mortgages, there is a limit to how much you can overpay per year (typically 10%), so it’s worthwhile finding out your mortgage’s overpayment limit and then making sure your overpayments are within this.
Another thing to consider is if your mortgage has an early mortgage repayment fee. This usually applies if you want to pay off your mortgage as one lump sum. Most lenders will charge a fee for this, which could potentially cancel out any savings gained.
What is the fastest way to pay off a mortgage?
Unless you’re fortunate enough to pay off your mortgage as one lump sum, making regular overpayments is probably the quickest way to pay off a mortgage. Even a £50 overpayment each month can have a significant impact on your mortgage term.
For example, a £50 monthly overpayment on a £200,000, 30-year loan with 5% interest would shave two years and ten months off the term! To work out how much quicker you could pay off your mortgage, take a look at Money Saving Expert’s mortgage overpayment calculator.
The case for building savings
It’s advisable to have a savings account that is well-funded, as it can serve as a valuable financial buffer in times of unforeseen emergencies - such as job loss or illness. This can provide a sense of security, knowing that there’s a safety net in place to help cover any unexpected expenses that may arise.
What are the reasons to save rather than overpaying a mortgage?
There are several reasons why people choose to put their spare cash into savings accounts, rather than put it towards their mortgage. Building an emergency fund and paying off other debts are two significant savings goals that we’d recommend prioritising over mortgage overpayments.
- Emergency Fund: Before overpaying your mortgage, ensure you have an adequate emergency fund in your savings. Financial advisors often recommend having three to six months' worth of living expenses set aside.
- Other Debts: If you have high-interest debts like credit card balances, it's generally wiser to pay those off before aggressively overpaying your mortgage.
- Interest Rates: Compare the interest rate on your mortgage with the potential returns from other investments. If your mortgage has a low-interest rate, you might be better off investing your extra funds elsewhere such as a high interest rate savings account.
- Future Goals: Consider your long-term financial goals. Are you planning to move in the next few years? Do you have other big expenses on the horizon, like home renovations, education, a wedding or starting a business?
- Comfort: Some people value the emotional satisfaction of being mortgage-free more than the potential financial gains from investing. It's essential to strike the right balance between financial prudence and emotional well-being.
When should I save instead of overpaying?
As a general rule, if your mortgage rate is around the same, or higher than, your savings rate, then it makes sense to overpay. However, if your savings account has a higher interest rate than your mortgage, then it would be better to put any spare cash into that savings account and let it build interest. You can then use that money to make a lump sum overpayment later on.
Next steps...
The decision to overpay your mortgage or save depends on your unique circumstances and goals. It's worth discussing your options with a financial advisor who can provide personalised advice based on your situation.
Whether you choose to become mortgage-free sooner or build a robust savings account, remember that both paths have their advantages. The most important thing is to make a decision that aligns with your financial aspirations.