It’s oft asked... “Should I pay off my mortgage or save?” Done correctly, using spare cash to overpay a mortgage is much more profitable than bog-standard saving. Yet it's not that simple, questions abound over cash ISAs, repayment penalties, emergency funds and more. This step-by-step guide includes the specially designed ‘Should I overpay my mortgage?’ calculator.
Also read: Should I Pay Off My Student Loan?
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Normally it’s a no brainer: those with both debts and savings are seriously overspending, thus a simple solution is repay all debts before you save. For a full explanation for dealing with credit cards and loans, read the Should I Pay Off Debts With Savings? article, but let me briefly summarise it here.
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£1,000 Debts |
on a Credit card at 18% |
Interest Cost £180 |
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£1,000 Saving |
In a Savings account at 4% after tax |
Interest Earned £40 |
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It's as simple as that. Debts usually cost more than savings earn, so cancel them out and you're better off. The only exceptions are where there are penalties for clearing the debt, as is common with loans, or if the debt is temporarily cheap you could make more saving the money in a high interest savings account, as with 0% credit cards (see Stoozing: Make Free Cash From Credit Cards).
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It naturally follows that you should clear the most expensive debts first. Over the long run mortgages are cheap compared with credit cards or loans, so clear those before shoving cash towards the mortgage.
The exceptions to the rule
The main exception is student loans, and by that I mean any loan from the official Student Loans Company. This is because the interest is set at the rate of inflation, making it the cheapest possible long term debt, so it’s rarely worth paying off any more quickly than is necessary (see Student Loans: Should I Pay them off?).
It’s also arguable that if you’re a good credit card tart and constantly rotating debts on 0% cards, there’s no need to pay these off quicker either, but this strategy should only be adopted by those who seriously play the balance transfer tarting system.
From this point on, I’m going to assume you’re free of all other more expensive debts (that you’re able to repay more quickly) and have spare cash.
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Many people don't think of their mortgage as a debt, but they’re wrong. Take a very simple scenario:
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£10,000 Mortgage Debt |
at 6% |
Annual Interest Cost £600 |
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£10,000 Saving |
at 4% after tax |
Annual Interest Earned £400 |
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Even for a basic rate taxpayer, while the difference between the cost of the mortgage and the gain from saving is smaller than with other debts, it’s still significant and that’s compared to a Top Savings Account. Higher rate taxpayers, or those with worse savings accounts, will find the gap much bigger.
This means on purely a numbers game, anyone whose mortgage rate is higher than the after tax interest from savings should pay off the mortgage, as they’ll be better off. Having said that, before making this decision it’s worth checking to see if you can cut the cost of your mortgage, see the Cheap Mortgages Guide or Cheap Remortgages Guide for more on that.
The ‘Should I pay off my mortgage?’ video clip
Cash ISAs break the rule
Every year, each UK adult is allowed to save up to £3,600 in a cash ISA, which is effectively a tax-free savings account. The fact the interest isn’t taxed means the gain from this usually outweighs or equals the cost of mortgage debt. Add to that the fact that if you don’t use your ISA allowance each tax year, you lose it, it’s worth filling each year’s ISA up before repaying the mortgage. Though do ensure you’ve got the top cash ISA or it skews the maths.
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To really clear it up, take this a step further and think of ‘paying off your mortgage' as a form of saving. To earn £600 a year after tax on £10,000 in a savings account, a basic rate taxpayer would need an interest rate of 7.5% and a higher rate taxpayer an enormous 10%.
This is a phenomenal, gobsmacking, unheard of amount that you simply can't get safely in any normal account (some Regular Saver Accounts pay close to this much but only on a very limited amount of cash and tend to have bizarre terms), which shows just how profitable overpaying a mortgage can be.
Use the calculator to find the specifics in your case:
Once the calculator tells you what savings rate you need, check out the top savings account or Where To Start With Savings articles to see what’s currently available. For the vast majority of people, making extra mortgage repayments wins (though as noted earlier, always ensure you’ve used your cash ISA allowance first).
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Always correctly time mortgage overpayments |
Mortgage companies calculate the interest owed on a mortgage daily, monthly or annually; which one makes a huge difference. With monthly, and especially annually, calculated mortgages, it’s crucial to time any extra repayments correctly. Money put towards the mortgage only counts after the calculation is made; so don't put your money in too early as it won't have an impact and you'll miss out on interest you could’ve earned in a savings account.
Those with interest only mortgages need to be careful. Normally the repayments only go towards repaying the interest of the loan, not the capital (the actual amount you borrowed). So ensure any extra payments you make specifically go towards decreasing the capital (in other words decreasing the actual debt) to attract less interest.
Checklist of when to pay
First establish how the mortgage interest is calculated; call the lender and ask if need be. If it’s daily there’s no problem. If it’s monthly, quarterly or annually, ask for the date the calculation is made.
Then rather than making mortgage overpayments willy-nilly, simply move it into the top instant access savings or instant access cash ISA, so you’re earning interest in the meantime. Then arrange to make the mortgage overpayments a few days before the calculation is made.
If you have a substantial lump sum to overpay, ask the mortgage company if it will automatically make a calculation even if it’s not the calculation date, if it will, fantastic.
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It all sounds good so far doesn’t it? Simply dosh the money into the mortgage. Unfortunately it’s not that simple, there are a number of things to check first.
Some mortgages penalise you for paying them off more quickly, especially if you have a special offer fixed or discount rate deal (see the Cheap Mortgage or Cheap Remortgage guide).
This is because lenders want you to stick with them once the cheap rate ends, as at that point their rates shoot up. Thus it’s not in their interest to let you pay off the mortgage more quickly – after all the longer it takes you to repay, the more they earn.
Check whether there are any penalties or additional costs to making extra or higher repayments. If there are these are likely to outweigh the gains from repaying the mortgage in which case it’s time to start saving. Thankfully these penalties are becoming rarer, though most mortgages will allow you to make “overpayments” (i.e. paying more than the regular amount) in some form.
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Put your money into most mortgages and it's gone - you're effectively locking it away, losing the ability to use it in the future. Therefore the interest gain must be balanced against this limited flexibility.
Good old fashioned budgeting logic says it’s always worthwhile having a cash emergency fund. While for people with expensive card and loan debts I generally disagree (see Should I Pay Off My Debts?), if you’re debt free apart from a mortgage, this is a good idea.
It’s worth having three to six months worth of cash stored away; enough to live on if you lost your job or had other issues. Mr Hallis, my A Level economics teacher would probably have called this “a premium for liquidity”, in other words you’re sacrificing some interest for easy access to the cash if needed.
Consider the potential outcome with no emergency fund. Put all your cash in the mortgage, and something happens and without savings you would need to fund this with credit card or loan borrowing for easy quick cash – and that’s expensive.
Therefore only start dumping cash in the mortgage once your emergency fund is up and running.
The big exception - mortgages with flexible features
Some people have mortgages with flexible features (or super-flexible offset or current account mortgages), meaning you can overpay or borrow-back (i.e. put the money in to pay off the mortgage but then withdraw it without penalties when you need it). If that's the case there’s no problem putting all spare cash in the mortgage – as it can be used as a high rate savings account.
This may prompt you to think flexible mortgages are therefore always best. Yet the problem is their interest rate is usually higher than standard mortgages, and the extra cost of the debt more than out-balances the gain on savings for most people. Full details on this and whether it's right for you are in the Mortgage and Remortgage guides.
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Now we hit interesting territory (forgive the pun). Investing means putting the money in a financial product that involves taking a risk – in the hope that the money will grow more quickly, but it could lose.
While the calculator shows it’s virtually impossible for most to earn more interest by saving than overpaying a mortgage, the same isn’t true with investing. A top performing investment will pay substantially more than 10% a year, yet one that performs badly can lose serious amounts of money too. This includes buying more property, possibly as a buy to let, rather than paying off your home - if it goes well you'll gain, if it goes badly you'll lose; there are no guarantees.
At this point I should point out, I don’t cover what to invest in as there’s no right or wrong answer, only how to buy investments the cheapest way (see Cheapest Way To Buy Shares, Cheapest Way To Buy Funds) so won’t be taking you much further along this road.
However, investing isn’t wrong. Done well it’s very profitable, provided you understand the risk you’re taking. To hope to generate the amount of investment returns equivalent to paying off your mortgage, you’d need relatively high risk investments; yet paying off the mortgage gives you a surety of the return.
Isn't paying off your mortgage investing in the property market anyway?
No. Buying a house in the first place is investing in the property market. Repaying your mortgage more quickly is paying off an outstanding debt. While the two acts are part of the same thing, by repaying your mortgage more quickly you're not altering the state of your investment - your house is neither more nor less likely to rise or fall in value.
The same £100 a month in a savings account, even at a very high 6%, would only earn a basic rate taxpayer £9,450 over the same time period or a higher rate taxpayer £6,660.
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Pay £100 more off your mortgage compared to saving it | |||||
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Method |
Time Taken |
Basic Rate Tax Payer |
Higher Rate Taxpayer | ||
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Interest |
Gain |
Interest |
Gain | ||
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Build savings |
16 years |
Earned £9,450 |
- |
Earned £6,660 |
- |
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Overpay mortgage |
16 years |
Saved £14,500 |
£5,050 |
Saved £14,500 |
£7,840 |
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Figures based on mortgage rate of 5.5% with an original term of 20 years and savings rate of 6%. | |||||
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