PAY DOWN
Is it better to overpay a mortgage or put cash in a savings account? Experts explain
We look at which option leaves you better off
IF you're lucky enough to have surplus cash left over after bills and other living costs are met, it can be tricky to decide what to do with it.
Overpaying your mortgage while interest rates are high seems a sensible move - but is it better off in a top rate savings account?
1
Higher interest rates in the last couple of years means it can finally pay to be a saver.
Even though the Bank of England base rate was cut last month, there are still savings accounts with rates of up to 7% up for grabs.
These top payers can help see your cash pile steadily grow meaning you essentially get money for nothing.
On the other hand, higher mortgage costs have created a huge bill burden for many households.
Read more on savings
Overpaying the debt helps bring down bills and means you become mortgage free faster.
Here's how the two options compare...
Paying off your mortgage
Making overpayments on your mortgage can be a shrewd move for the long term.
You pay interest on the outstanding balance throughout the term, so the more you pay off earlier, the less interest you pay overall.
Most read in Money
Due to the size off mortgages, paying even small overpayments can save you thousands of pounds in the long run.
What is the Bank of England base rate and how does it affect me?
For example, on a £100,000 mortgage on a 25-year term paying an extra £90 a month would save over £4,800 of interest and see the loan repaid nearly three years early, according to calculations by Halifax.
Even an extra £25 each month on a £250,000 mortgage fixed at a rate of five per cent would save £23,986 over a 40-year term, found early repayment app Sprive.
There are different types of mortgages and your deal will affect how much extra you can pay.
Those on variable rate mortgages such as trackers can often make extra payments without any caps or limits.
However, the majority of homeowners are on fixed-rate mortgages.
These usually only allow customers to make overpayments of up to 10% of the outstanding mortgage balance in a year.
If you pat more than this, you'll trigger costly early repayment charges.
Check the small print on your deal carefully to make sure you don't accidentally breach the conditions.
Payments can be regular or ad-hoc. If you have a lump sum of cash you can put it towards overpayments or set up a regular extra payment that can be cancelled if you're short of cash one month.
This can be great for people who work on commission or whose income levels vary from month to month.
If you've paid extra on your mortgage, you may see the benefit when you come to remortgage. Paying off the loan faster can help you move to a lower loan to value bracket earlier where you can usually benefit from cheaper mortgage rates and thus lower interest repayments.
Once your cash has paid off the debt, you won't be able to get it back.
So you need to make sure that you have other ways to fund unforeseen expenses that life can throw up.
Building a savings pot
Many people funnel surplus cash into a savings account each month.
As a general rule of thumb, it's a good idea for most people to have at least three month's worth of income in an easy access savings account.
This is cash that can cushion you from expensive financial shocks such as losing your job or having to buy a new car.
The benefit of an easy access savings account is that you can call on the cash whenever you need it without paying penalties or giving notice to withdraw.
The top easy access accounts pay as much as 5% so while you don't need to use it, the money can generate extra.
If you have emergency funds set up, putting surplus money into savings can still make sense.
But it might be better to put cash into accounts that pay higher rates but that come with more restrictions.
For example, regular savings accounts pay as much as 7% with first direct and the co-op but you usually need to pay money each month for a year and not withdraw money before this time.
Or you could lock away money in fixed-rate accounts that pay up to x% if you are sure you won't need to see money for up to five years.
This can be a great way to pull together lump sums of cash for expensive events such as holidays, Christmas or even a wedding, avoiding turning to credit cards, loans or other forms of borrowing than can be costly.
It's important to understand the impact that inflation can have on your savings.
You need to make sure cash is kept in an account that pays interest at a higher rate than inflation otherwise the value of your pot is in effect being eroded.
Inflation is measured each month and can change a great deal over the course of a year.
At the moment, consumer price inflation is measured at 2.2% but this time last year it was 6.7%.
Which is best?
Choosing whether to prioritise savings or mortgage overpayments will depend on your personal circumstances.
Experts say that it usually depends on the interest rate on your mortgage versus the best savings rate available to you.
If you have a low mortgage rate, the interest charged will be less than the interest you can make with the cash sitting in a savings account.
Sarah Coles, head of personal finance at savings platform Hargreaves Lansdown, said: "Some people can get much more interest on their savings than they’re paying on their mortgage – with some mortgages under 4% and some savings offering 5% or more.
"On the flip side, some people will pay well over 5% for their mortgage, particularly if they don’t have much equity in their home or if they’re not considered a particularly attractive customer for the banks.
"But this decision is about more than just the rate. It depends entirely on your overall financial position."
Rachel Springall from comparison site Moneyfactscompare.co.uk, added: “It may seem sensible to proactively overpay a mortgage to reduce the debt owed, but its crucial consumers seek advice before they do so, particularly if they do not have a savings pot on the side to cover unexpected expenses.
"As a typical rule, if a mortgage is being charged a higher interest rate than on savings, then it can be a good idea to overpay.
"Anyone looking to prioritise their savings will need to take into consideration any tax that needs to be paid, such as if they do not use an ISA and their non-ISA earnings ends up breaching their Personal Savings Allowance (PSA).”
You should also factor in your retirement situation when weighing up your options, according to Karen Noye, mortgage and financial planning expert at Quilter,
She said: "Another consideration here is when your mortgage term ends, as ideally you do not want your mortgage debt running into your retirement.
"However, overpaying on your mortgage should not hamper how much you are saving for retirement and while everyone’s financial circumstances are different by and large it is best to prioritise your pension.
"Money put into a pension benefits from tax relief and also benefits from often being invested in the stock market for a long period of time, enjoying the magic of compound interest and the possibility of riding out any volatility in the markets.
"But like lots of things in life there are exceptions and there a huge number of factors that will influence what your best option is such as your mortgage term and interest rate, as well as your age and job status.
READ MORE SUN STORIES
"It is therefore key to weigh this all up and it is best to speak to a professional financial adviser who can help you navigate these variables and get the best possible outcome for your unique financial situation."
You can search for a local financial adviser close to you at unbiased.co.uk or vouchedfor.co.uk.
How you can find the best savings rates
If you are trying to find the best savings rate there are websites you can use that can show you the best rates available.
Doing some research on websites such as MoneyFacts and price comparison sites including Compare the Market and Go Compare will quickly show you what's out there.
These websites let you tailor your searches to an account type that suits you.
There are three types of savings accounts fixed, easy access, and regular saver.
A fixed-rate savings account offers some of the highest interest rates but comes at the cost of being unable to withdraw your cash within the agreed term.
This means that your money is locked in, so even if interest rates increase you are unable to move your money and switch to a better account.
Some providers give the option to withdraw but it comes with a hefty fee.
An easy-access account does what it says on the tin and usually allow unlimited cash withdrawals.
These accounts do tend to come with lower returns but are a good option if you want the freedom to move your money without being charged a penalty fee.
Lastly is a regular saver account, these accounts generate decent returns but only on the basis that you pay a set amount in each month.
Topics