Should I use my savings to overpay my mortgage?

15 June 2012

Q

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?
From
HM/West Sussex

A

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.

[Video:1]

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.