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Should I overpay my mortgage?

Can you use savings to overpay?

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Martin | Edited by Dan

Updated November 2016

Should I overpay my mortgage with my savings?With savings rates at rock-bottom, overpaying on your mortgage is often a no-brainer. And for many it is, with gains of £10,000s in interest possible.

But there are negatives – including repayment penalties, losing an emergency fund and more. This guide helps you decide if it's right for you.

Overpaying often wins – but is not for everyone

Get it right and overpaying your mortgage can be a huge cash boost, because...

  • You'll be eating into the debt you've built up from buying a home, meaning you pay it off quicker.
  • You don't pay interest on the amount you overpay.
  • The money you'd save on interest often beats the returns possible by putting it in savings, given savings rates are currently so pitiful.

Overpaying means you make the same gain as saving at your mortgage rate. If you've a 3% mortgage, you'd need savings paying at least this. And, if you've used up your personal savings allowance, you need savings paying even more; higher-rate taxpayers'd need to earn 5% – impossible to get on standard savings now.

Here are some real-life examples:

Started making overpayments on my mortgage seven years ago. Saved £18,600 in interest and paid up eight years and three months early. So my ex-mortgage payment can now go towards a fantastic retirement pot. – Debbie

From 2005, threw an extra £600 per month at mortgage, paid off 4yrs early. #Thanks – Steve

But before you chuck all your savings at your mortgage, know the following...

Most can overpay 10% per year, but check. Get it wrong and you risk £1,000s in fees

Most lenders allow you to pay 10% of your mortgage balance as an overpayment per year if you're still in your introductory fixed, tracker or discount period.

If you're beyond that intro deal and paying your lender's standard variable rate (SVR), you can usually overpay by as much as you want. But many SVRs are expensive, so if on one it's best to check if you can save by remortgaging, rather than only overpaying.

However, the 10% rule is not universal. Some lenders punish those who try to overpay by more (see the What type of mortgage to choose guide for details).

Fees for paying too much are typically between 1% and 5% of the amount overpaid depending on your mortgage, though the fee you pay usually decreases the closer you are to the end of the fixed or discount period. The amount you pay as a penalty will vary between mortgage deals.

Some may levy a flat rate of 5% regardless of when you may make any overpayment while others - particularly fixes for 5 yrs or longer - will often charge the same percentage on your overpayment that equates to the number of years left on your loan.

Say you’ve a 5-yr fix on a £100,000 mortgage and decide to overpay a lump sum two years into the deal. However, instead of sticking to the 10pc (£10,000) limit free of penalty, you overpay £15,000 instead.

This means you must pay a 3% penalty on the extra £5,000 overpayment - £150. However, this 'percentage left on loan' rule of thumb is very rough so always double-check with your lender.

The reason for such harsh penalties is because lenders want you to stick with them once the cheap rate ends and because they've also budgeted to earn a certain amount of interest from you during the mortgage deal, and overpaying means they'll get less.

If you've other, expensive debts, clear 'em first

A crucial rule of debt repayments is: clear the most expensive debts first. Do so and the interest doesn't build up as quickly, saving you cash and giving you more chance of clearing debts earlier. Therefore, as a rule of thumb...

Clear high-interest credit cards and loans before overpaying your mortgage, as they're usually more expensive.

Yet as with any rule of thumb, there are exceptions. Check all of the following that apply...

You have outstanding student loans

You are a 0% credit card tart

You may not be allowed to overpay a loan (taken out pre-2011)

Ensure you have sufficient emergency funds

Good old-fashioned budgeting logic says it's always worthwhile having a cash emergency fund. While for people with expensive card and loan debts we generally disagree (see Use Savings To Repay Debts?), for those who are debt-free, apart from a mortgage, this is a good idea.

Overpay most mortgages and the cash is gone. So if you've an emergency (leaking roof or redundancy, not new shoes) and you'd overpaid with all spare cash, you could be forced to borrow again instead. Your earlier overpayments may not stop lenders charging you for being in arrears if you miss monthly repayments (see Mortgage Arrears Help).

So it's always a good idea to keep an emergency fund in a top savings account – three to six months' worth of cash is a good guide, enough to live on if you lost your job, for example. If you're thinking of using newly arriving extra income (such as a pay rise) to overpay your mortgage, then build up an emergency fund first.

This applies even if the calculator shows you'd be better off overpaying your mortgage. It's what's known as 'a premium for liquidity'. In other words, it's sacrificing some interest for easy access to cash when needed.

Overpaying vs saving – which wins?

If you've got this far, we're going to assume you're debt free, you have an emergency fund, and have a mortgage that allows some level of penalty-free overpayment. So now you need to check whether you should overpay your mortgage or save the cash elsewhere.

Overpaying your mortgage is all about this key decision. And what you should do depends on what makes financial sense. The simple rule of thumb is:

If you can get a higher rate on your savings than you pay on your mortgage, saving wins. But if your mortgage rate is more than your savings rate, then it makes sense to overpay.

A simplified example should help...

If you've £10,000 mortgage debt at 2.99%,
Annual interest cost is: £299

If you have £10,000 savings at 1.27%,
Annual interest earned is: £127


Pay off the debt with the savings and you are £172 a year better off. We've not included tax deductions in the example as the new personal savings allowance means most people don't pay tax on bank interest received.

You are allowed to earn up to £1,000 of interest tax-free

Since 6 April 2016, the new personal savings allowance means every basic-rate taxpayer can earn £1,000 interest without paying tax on it; equivalent to the interest on £75,000 in the top easy access savings account - so 95% of people won't pay any savings tax at all.

Higher-rate taxpayers get a £500 personal savings allowance, but additional taxpayers don't get any.

This doesn't just apply to savings accounts, it's for any interest from bank accounts, credit unions, building societies or even peer-to-peer lending. And it'll be automatic, you'll be paid interest gross (ie, with no tax taken off). For full info and what to do if you'll earn over the limit see our how the personal savings allowance works guide.

This can have an interesting effect because some may have savings where interest exceeeds the personal savings allowance.

Martin Lewis says...

For those with a decent whack of savings, whether to overpay your mortgage can get a little complicated. So I want to explain with an example scenario.

Here’s the set up – I’ve deliberately chosen easy numbers….

  • You’re a basic-rate taxpayer so you have a £1,000 tax-free personal savings allowance
  • Your mortgage rate is 2.8%
  • You have £40,000 of savings
  • Your savings are all at 3% interest
Therefore the total interest you’d earn in a year before tax is £1,200 of which £1,000 is tax-free, while the remaining £200 is taxed at the basic 20% rate.

To work out whether you should overpay you need to see if your mortgage rate is higher than the after-tax rate on your savings.  

Yet the personal savings allowance means even though all your savings are in one account, they’re actually at two different rates after-tax.

  • The tax-free rate on your first £1,000 of interest (which is generated from £33,333 of savings), is 3%.
  • The after tax rate on the remaining £200 of interest (the final £6,667 of your savings) is at 2.4% (as 20% off 3% is 2.4%).

Therefore the tax-free interest earns you more than the mortgage costs. Yet the taxed interest doesn’t so you you’d be best off to put £6,667 but no more towards your mortgage.

As you can see it is really worth taking this slowly and doing your sums.

So for some people you may find it worthwhile to overpay some of your mortgage, but not all. Main thing is to make sure it's worthwhile for you.

Are your savings rates as high as possible?

Before you say "my interest rate is crap, so I'll overpay my mortgage", you need to check if you can boost the rate you're getting.

This isn't a question of whether overpaying your mortgage beats your current savings. Instead, it must be "does repaying my mortgage beat the highest-paying savings available?"

Many people earn pitiful rates, and assume they can't improve them. Yet better deals are often available. So if you haven't already, check the Top Savings Accounts and Top Cash ISA guides for all the best rates.

You needn't switch to them right now, as overpaying your mortgage may win out. But at least know what's on offer, and compare against that to calculate the right option.

Overpaying vs Saving. Take our test

We've built a calculator which tells you how much interest you would need to get on a savings account to beat overpaying your mortgage.

Just enter your mortgage rate and select your tax rate to find your magic number...

Tool: Should I overpay my mortgage with savings?

From 6 April the new personal savings allowance (PSA) means every basic-rate taxpayer can earn £1,000 interest without paying tax on it (higher rate £500). This is reflected in the calculator below.

%

Once the calculator tells you what savings rate you need, check out the Top Savings Accounts or Top Cash ISA guides to see what's currently available. For the vast majority of people, making extra mortgage repayments wins.

The size of the savings possible

Overpaying can save you £10,000s over the lifetime of a mortgage. And, as the table shows, overpayments don't have to be big bucks. Even £50 or £100 a month can dramatically reduce the interest you pay, shorten your mortgage term, and will usually beat savings...

How much will overpaying your mortgage save you?
Saving/overpayment per month Mortgage term reduction Total mortgage interest saved overpaying a £150k mortgage at 2.99% (1) Interest if you saved the overpayment at 2% (2)
£10 Six months £1,420 £860
£50 Two years, four months £6,520 £3,500
£100 Four years, three months £11,790 £5,800
£200 Seven years, three months £19,800 £8,375
£500 12 years, seven months £33,530 £9,960
£1,000 16 years, eight months £43,680 £8,800

(1) The mortgage has a 25-year-term. (2) Savings are pre tax and stop as soon as the mortgage is paid off to make the comparison fair.

You can save such large sums because overpaying doesn't just get rid of the debt – it gets rid of the interest you would have paid on that bit of borrowing in the future too.

Remortgaging? Overpaying could mean you save twice over...

If you're overpaying your mortgage, you don't just get the advantage of paying interest on a smaller amount of debt. Overpaying also means your loan to value ratio falls faster.

And if your LTV falls, it means when it comes to remortgaging, you may be able to get a cheaper deal than if you hadn't overpaid.

Therefore if you've got a sizeable savings pot, or you're overpaying month by month, by using savings to reduce your mortgage borrowing and cutting your LTV, you may get access to cheaper rates.

In truth, you'll need to be close to one of the key trigger LTV thresholds – where acceptability increases substantially and cost drops – for overpaying to make a difference. But if you are, the savings are huge. As a rough rule of thumb, the main thresholds are:

95% LTV: Above this, you won't be able to remortgage at all.
90%, 85%, 80%, 75% and 60% LTVs: Go below each of these and the top mortgage deals get cheaper.

Rates get cheaper as your LTV drops...
2 year fix examples 5 year fix examples
95% 3.29% 3.97%
90% 1.99% 2.93%
75% 1.33% 2.23%
60% 0.99% 1.99%
Rates correct at Jun 2016

How to cut the cost of your mortgage

If you are close to an LTV band, or you're coming to the end of a mortgage deal, it's worth checking the market as mortgages have never been cheaper. Take a quick look at our Mortgage Best Buys tool to see what rates are available or find a broker to help you search in our Cheap Mortgage Finding guide.

Find the best buy mortgages

If you're ready to get a mortgage, tell our Mortgage Best Buys tool what you want, and it'll speedily find the top deals for you.

Ready to remortgage?

If you want to change mortgage, this free guide has tips on when you should & shouldn’t remortgage and how to grab top deals.

Ready to get a mortgage?

Want to get on that first rung? Our free guide helps you find the cheapest mortgage and boost your chances of getting accepted.

Calculate how much you'll save by overpaying

Working out the savings made by overpaying your mortgage isn't simply a matter of chopping the lump sum repayment from your balance. It cuts future interest and hopefully will mean you're mortgage-free much earlier.

Mortgage overpaying Q&A

If it all adds up that overpaying is the right option for you, here's how to do it, and other things to consider before taking the plunge...

  • How do I overpay my mortgage?

  • Should I overpay my mortgage each month or ask my lender to officially reduce the term?

  • I have an offset mortgage. Can I still overpay?

  • Does it matter when I overpay?

  • Is it worth investing rather than saving?

  • Isn't paying off a mortgage investing in the property market anyway?