mortgage overpayments

Savings or Mortgage Overpayments?

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The one thing that is standing in the way of most people truly achieving financial freedom is the monthly mortgage repayments. With this alone taking up a significant proportion of anyone’s income it should come as no surprise that many people can’t afford to retire early or take a gap year from work and travel purely because of mortgage commitments.

One of the first steps many take when looking to work towards financial freedom is starting a savings account and investing as much as they possibly can into this, but is this the right way to go? Due to our continued low interest rates, savings accounts are now offering very little return. The best buys as far as the savings account market goes are a fixed rate 1.99% for one year, 1.75% for an easy access account and 2% on an ISA.

Looking at the maths, the answer is pretty clear. Saving £100 per month over the course of 2 years in an account with a 2% interest rate, you will have made £2446.57. Only a £46.57 return on your initial contributions.

On a £150,000, 4% interest rate mortgage you will be paying approximately £790 per month. If you then overpay £100 per month instead of placing this in your savings account after two years and £2400 your remaining debt will have been reduced by £2503. This £103 saving on mortgage interest fees is therefore more than double with what you could have received from saving your money!

If you then continued to make a £100 overpayment for the duration of your mortgage you will reduce the term by 4 years and 5 months and save over £17,000 in interest! This will of course be a greater saving if your mortgage has a higher interest rate! As food for thought, a £200 overpayment per month would reduce your mortgage term by 7 years and 6 months, getting you to financial freedom earlier than you may have previously thought possible!

Granted, you should always have some level of savings in case of an emergency, with the economy still in its relatively uncertain state we cannot become too complacent. Offset mortgages are perfect for those who want to reduce the cost of their mortgage whilst still having access to their savings!  With these mortgages you ‘offset’ the savings against the mortgage get and instead of earning interest on your savings you get a reduction on the interest charged on your mortgage. This can be potentially complex and will involve remortgaging (which is likely to result in a cheaper mortgage anyway as mortgage rates are at rock bottom lows right now) and changing your current and savings accounts so you should always discuss the pros and cons of this with a financial advisor, a dedicated mortgage broker, such as First Mortgage or your current bank who may be able to switch you to their offset products. RBS have a useful calculator which can give you an approximate idea of how much you could save in interest costs and your mortgage term by switching to an offset mortgage here.

Do you save or make mortgage overpayments?

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One Response to Savings or Mortgage Overpayments?

  1. JoeTaxpayer says:

    With mortgage rates so low, the ‘last’ thing someone should do is pay early. First is to be sure they are depositing to any match retirement account. (popular in the US, not sure if UK has similar plans.) Second, pay off any high interest debt. Yes, I’d seen people to be paying off their 4% mortgage but still paying 18% on a charge card. Third, fund the emergency account to 9-12 months’ expenses.

    Last – decide between investing long term with the risk that brings, vs the fixed rate savings of the mortgage. Paying the mortgage early really is choosing a long term fixed rate that’s guaranteed. The market of course has its ups and downs, so the potential 8-10% return brings risk.

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