With savings rates at an all-time low, many home-owning savers might be thinking overpaying on their mortgage is a no-brainer.
But there are spanners in the works such as repayment penalties, how you keep emergency funds, and more. This guide helps you decide if it's right for you.
In this guide:
Important checks before you start
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Paying off a mortgage versus saving
Before getting on to mortgages specifically, it's important to understand the basic principle of how all debt and savings interact. Borrowing and saving are two sides of the same coin...
Is it worth overpaying my mortgage? Take our test
To really cement this, start to think of overpaying your mortgage as a form of saving. Take repaying a 5% mortgage...
To earn £500 a year after tax on £10,000, a basic-rate taxpayer needs an account paying 6.25%, higher rate 8.33% & top rate 9.1%
How much will I gain 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.
Time mortgage overpayments correctly
Mortgage companies have four ways of calculating the interest you owe - daily, monthly, quarterly or annually. Check your mortgage to see which it is - though thankfully the majority of new mortgages are on daily interest, which is better for you as an overpaying borrower.
Key alternatives to overpaying
If it all adds up that overpaying is the right option for you, there are a couple of other things worth considering flirting with before you take the plunge. We're not saying "these are better" - but we'd be a little remiss if we didn't at least nod to them.
Consider filling up your cash NISA allowance
Every year, each UK adult is allowed to save a lump in a cash NISA (£15,000 in 2014/15 tax year. A NISA is effectively a tax-free savings account. The fact the interest isn't taxed means the gain from this can outweigh the cost of mortgage debt, or at least closes the gap compared to other savings.
However, even if it doesn't add up to put cash in a Top Cash NISA now, it's worth noting if you don't use your cash NISA allocation in a given tax year, you lose it. And remember once cash is in a NISA, it's then tax-free year after year until you take it out, and you can do a NISA transfer in future to keep rates high.
Therefore you may decide that it's worth taking the small financial hit now to earn a little less with your money, in order to fill up your cash NISA allowance while you can. This also means your cash remains more liquid and available.
Is it worth investing rather than saving?
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, although it could lose.
While our calculator shows for many it's very tough to find savings that beat 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 putting cash into your pension or buying more property (possibly as a buy-to-let) rather than paying off your home loan. If it goes well you'll gain, if it goes badly you'll lose. There are no guarantees.
We 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 we won't be taking you much further along this road. If you need help on this, seek independent financial advice.
However, investing isn't wrong. Done well it's very profitable, provided you understand the risk you're taking.
Yet to generate the amount of investment returns equivalent to paying off your mortgage, you'd usually need relatively high-risk investments - overpaying the mortgage gives a surety of return.
Isn't paying off a 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.