Should I use my savings to overpay my mortgage?
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Question
I have some money set aside but I’m not sure what to do with it.
Considering how low interest rates are, is it best to pay off my mortgage or put the money into a savings account instead?
Answer
This is a question I get asked very often.
The answer really depends on what will give the most effective return on your capital.
Paying off debt gives an effective return equivalent to the mortgage rate. As the interest rate you are being charged on your mortgage is likely to be higher than the rate you would be able to get on a savings account, paying off the mortgage is likely to be the better option in terms of return.
There is also no tax to pay as there is no interest earned - making the return even better.
For example, a borrower with a mortgage at 4% would need to earn a gross savings rate of 5% as a basic-rate taxpayer or 6.67% as a higher-rate taxpayer to get the same effective return as overpaying on their mortgage.
However, paying off your mortgage will mean that, unless you have a very flexible mortgage deal, you won’t be able to get the money back should you need it. It is important to have some liquid savings that you can call upon if necessary, rather than ploughing everything into the mortgage, which may require you to remortgage in order to release the equity at a later date.
I would suggest that you make sure you have a decent emergency savings pot and once you have then the remainder of the money could be used to overpay your mortgage.
For all the best current savings rates check out our compare savings and cash ISAs service.
David Hollingworth
is a mortgage expert at London & Country Mortgages in Bath.
Your Comments
Excellent response, David, except the the 2nd sentence would have been better as "The answer really depends on what will give the most effective return on your capital, balanced against keeping a emergency savings pot." I'd been left wondering if you were going to mention that!
The benefit of a flexible mortgage is clear. I sold ISAs and 'saved' the cash by overpaying 90,000 off my 93,000 mortgage. The lender must have had some surprise when I took it all back out again 5 months later to buy a flat for my student daughter. Overall it gave excellent return for what was effectively a "no-notice cash savings account".
Excellent article Mr. Hollingworth.
However you forgot to point out how much more attractive is a person with low or no mortgage.
I overpaid my mortgage down to a very low level, then needed a bit of spare cash for a few months, and the local bank managers fell over themselves in their eagerness to lend to me. It wasn't my charm or beauty, they just knew that there was no chance of them not getting their money back. I took the best offer.
Another good reason for reducing your mortgage is that your mortgage company will be less enthusiastic to foreclose on you when you lose your job. In times of anxiety get rid of all debts!
