Yahoo Finance The mortgage overpayment hack that can cut your interest by thousands
As the Bank Rate has just increased to 5.25pc, many homeowners will be keeping a watchful eye as to whether mortgage lenders pass on this rate rise.
The average two-year fixed-rate is 6.85pc, according to analyst Moneyfacts – but several big name lenders have recently announced rate cuts.
High mortgage rates can spur homeowners to overpay their mortgage as a way to fight back.
Paying off larger chunks of your mortgage means you can speed up becoming mortgage-free, while drastically reducing the interest being clawed back by your lender.
But it’s not always the best course of action. By weighing up the interest being charged by your mortgage lender, versus interest you’re paid on your savings, you could be better off squirrelling your cash into a savings account instead.
That’s where our calculator comes in.
Simply enter a few details about your mortgage, the amount you’re considering overpaying by, and how much you’re earning from your savings, and we’ll reveal which option could be better for your cash.
Overpaying your mortgage can save you tens of thousands in interest
Most lenders allow customers to repay up to 10pc of their mortgage balance each year without incurring an early repayment charge – earlier this year NatWest increased its cap on overpayments to 20pc.
You can either commit to overpaying by a regular monthly amount, or pay as a lump sum whenever you have some cash to spare.
While some lenders have started cutting mortgage rates, fixed term deals are still expensive, and paying down your home loan can have a big effect.
For a borrower with a £350,000 mortgage on the average two-year fixed rate of 6.85pc (as of August 3, according to Moneyfacts) and a 25-year term, overpaying by £200 a month would save nearly £76,500 in interest and result in the debt being cleared four years and three months early.
In comparison, if you put the same £200 a month into a savings account that pays the current average easy access rate of 2.8pc over 21 years – the amount of time it would take to pay off your mortgage with overpayments – you’d earn £17,782 in interest.
This suggests overpaying your mortgage could be a good choice, as saving £76,500 in mortgage interest may be preferable to the savings interest you’d earn.
Overpaying may help when you come to remortgage
Borrowers with more equity in their property may be able to secure a better rate when they come to remortgage.
“Overpaying isn’t necessarily going to be looked at more favourably by a lender as they will always want to see that the mortgage is affordable,” said Mr Hollingworth.
“But it could reduce the loan-to-value (LTV) on the mortgage, which could open up a broader range of better rates. And a smaller mortgage should also mean that affordability is easier to meet – which again could help to open up the best choice of rates.”
Now read: Fixed-rate mortgage or tracker? How to tackle rising interest rates
When is overpaying not worth it?
Making the wrong decision between saving vs overpaying could cost you in the long run.
Right now some borrowers will still be locked into a super-low fixed mortgage rate, meaning you could be better off taking advantage of a top savings rate instead since many are paying more than 6pc.
For example, Atom Bank currently pays 6.05pc on a one-year savings bond.
The same borrower with a £350,000 mortgage on a fixed-rate of 2.2pc (secured when interest rates were much lower) and a 25-year term could save £16,737 by overpaying their mortgage by £200 a month, paying off their mortgage three years and eight months early.
But, if that £200 were to be saved in a savings account over this time instead (assuming the interest stayed the same), they’d earn £53,395 in savings interest – nearly £37,000 more than the interest saving they’d make by overpaying.
“It could make sense to build up a savings fund that could then be used to reduce the mortgage when the current deal ends,” said David Hollingworth, of broker L&C Mortgages.
Should you invest instead?
If other debt, retirement pots and emergency savings are in a good place, you may find yourself weighing up the benefit of investing versus paying down mortgage debt.
You certainly don’t need to pay out huge amounts to do either: regular investing at £100 a month over five years with average returns of 4.5pc equates to £6,590 (investment growth of £592.20). If you achieve 7.5pc returns, the balance rises to £7,110 (investment growth of £1,105). Both of these examples assume charges of 0.75pc a year.
Alternatively, using that same £100 a month to overpay a mortgage could still save you thousands. Taking the typical five-year fixed rate of 6.36pc (as of August 3, according to Moneyfacts) on a £300,000 mortgage (25-year term) would save a total of £37,489 in interest over the life of the mortgage and reduce your loan term by two years and eight months.
On paper, it makes sense to invest your cash if you think you’re going to make a return that’s going to be higher than the interest you’re paying on your mortgage.
But with mortgage rates edging towards 7pc – with scope to go higher if the Bank Rate fails to fall in line with predictions – then any investment will have to work pretty hard to provide a net return in excess of that.
And while the average fund whose remit is to invest up to 60pc of its money in stocks has returned 7.6pc over the past five years, according to AJ Bell, you may not have the appetite for stock market uncertainty.
An exception to this: young homeowners may be better off investing extra cash via a pension rather than overpaying their mortgage, according to research from Interactive Investor.
There’s no definitive “right” answer here. What you ultimately opt for may not be the bigger financial gain according to a spreadsheet or our calculator, but if it gives you the peace of mind you’re looking for then it could still be worth doing.
Now read: The beginner’s guide to Isas: how to invest and save, tax-free
This article is kept updated with the latest information.
