Do you have a mortgage and savings? If so, it’s almost certain this is the moment to change strategy. Saving rates are dire and are getting worse. So I want to urge you to urgently check now if you’d be far better off simply overpaying your mortgage instead – the gains can be in the £10,000s.
It’s now been over a month since the Bank of England cut UK base rates from 0.5% to 0.25%. Since then we’ve gradually seen savings account after savings account slash its interest – for example NatWest’s cash ISA’s has dropped to 0.01% and Santander’s halving the interest on its 123 current account.
Of course, cutting rate is meant to benefit those with mortgages, yet millions are locked in on fixed rates, or paying over the odds, so for many there’s little gain. That’s why I’m calling on everyone with a mortgage and spare cash to check if overpaying it is their best form of saving.
There’s full detailed help at www.mse.me/mortgageoverpay, but here are the six key need-to-knows
1 – The big question – is your mortgage rate higher than the rate on your savings?
If it is then, quite simply you’ll be better off by overpaying it. It’s basic maths. For example, £1,000 saved at 1% earns £10/yr. Instead use this cash to reduce a 4% mortgage and your interest costs £40/yr less, so you’re £30/yr better off.
And the compounded impact of this over years is enormous. Instead of saving, overpay £250/mth on a 20-year £150,000 mortgage at the current average standard variable rate of 4.8%, and you’d clear the mortgage six years earlier, saving £27,000 in interest. That’s massive. I worked this out using the mortgage overpay calc at www.mse.me/mortgageoverpaycalc. You can put your own situation in there too.
However, if you’re lucky enough to have a mortgage rate that’s lower than your savings rate, don’t overpay. Even though the calculator says you’ll gain, you’d gain more by saving
2 – Beware overpayment penalties
Most mortgages allow you to overpay up to 10% of your balance annually – even if you’re on a fixed deal. That’s a decent whack, but above it there are penalties. If you’re on the lender’s standard variable rate, overpayments are usually unlimited. However, if there are penalties, this will usually kill the gain from overpaying.
3 – If you’ve other more expensive debts, pay them off first
While a mortgage is likely to be your biggest loan, it might not be your most expensive. If you have other debt at higher interest, use any spare cash to clear that first, as it is costing you more.
4 – Ensure you ask for the repayments to shorten the term
Don’t let them just lower your future mortgage repayments, this effectively spreads the debt and means you don’t get as much benefit. When you overpay, ask it to keep your repayments fixed, which will effectively shorten the term of your mortgage, even if you’re making regular rather than lump sum payments.
However, please don’t read that as me saying “ask to shorten your term”. While cutting your mortgage term from 25 year to 20 years has the same effect as overpaying, you’re locked into it so can’t change back. By simply overpaying and letting that reduce the term gradually, you have flexibility to stop overpaying in future
5 – Always have a readily available emergency fund
It’s important to have one of these just in case the worse happens. As even if you’d overpaid your mortgage, and, say you then lost your job, you could face mortgage arrears. So always keep an emergency cash fund to cover at least three and preferably six months of all bills. The only exception is for those with flexible mortgages allowing you to withdraw overpayments – as you could then do just that in the event of emergency.
Having said that, there are a range of bank accounts that offer savers high rates, up to 5% or 6% but only on smaller amounts. So as these are higher interest than most mortgages cost they’re winners anyway – and a good place to keep the emergency cash. Full best buys in www.mse.me/bestbankaccounts.
If you can, get a cheaper mortgage elsewhere
If your mortgage rate is expensive, it’s always worth checking to see if you can get a cheaper one. Rates are at record lows at the moment – some are sub 1%, so see if you can switch and save. Like Kperat, who emailed “Fixed at 1.24% for 2 yrs, and reduced term to 13 years [effectively overpaying – ML] without paying more a month. Will be saving about £20,000 even after fees. THANKS.”
Overpaying won’t only help you save now, but may also help you to get a cheaper mortgage rate in the future. As it reduces your mortgage debt, it decreases your ‘Loan To Value’ (LTV – the % of the price borrowed against the total house value) ratio.
This is good as deals get cheaper each 5% lower the LTV, down to 60%. For example, the cheapest 2yr fix at 95% LTV is over 3%, but at 90% LTV it’s under 2%. On a £150,000 mortgage, that’s over £1,000 a year less.
Martin Lewis is the Founder & Editor in Chief of Money Saving Expert. To join the 10 million people who get his Martin’s Money Tips weekly email, go to www.moneysavingexpert.com/latesttip