Paying off your mortgage early can save you a huge amount of money in interest payments, but there are a few things to be aware of before you start overpaying your mortgage. We weigh the pros and cons of using your savings to pay off your mortgage early.
Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage or any other debt secured on it.
Paying off any debt that accumulates interest is always a sensible option as, more often than not, the interest cost of a debt will be higher than the interest earned on savings. However, there is a lot to consider before you make any decision on whether paying off your mortgage early is the best thing to do with your money:
First, you can make regular overpayments on your mortgage (pay more than the regular monthly amount demanded by your lender). You can make one-off overpayments or overpay your mortgage regularly.
Most lenders will allow you to do this without incurring fees, but many set limits on how much you can overpay. Be sure to check any limits that your lender might impose on overpayments to ensure that you don’t incur any charges.
Take a look at your finances to work out if you have any surplus cash that you can stash in your mortgage, each month. If you can overpay, it's well worth doing.
Say, for instance, you have £135,000 outstanding on your 25-year, 5.25% fixed rate mortgage. An overpayment of £100 a month would take your repayments from £809.98 to £909.98 a month.
However, it would also cut 5 years off your mortgage term and save you more than £25,000 in interest, making overpaying an option that's definitely worth considering in your quest towards paying off your mortgage early.
Check your mortgage terms and conditions to make sure overpayments are allowed
Find out if overpayments now might entitle you to a mortgage holiday later, should you need it
If you’re wondering how to pay off your mortgage early, overpaying will definitely have a big impact on reducing your debt.
If you have an interest only mortgage, remember that paying extra each month will not make any difference to your overall mortgage debt. If you want to use savings to reduce your overall mortgage debt by making overpayments, you will need to either set money aside in a savings account or switch to a repayment mortgage.
Well, as ever, that depends on your circumstances, but it certainly can be worth it.
It's a good option if you would normally put money into a savings account every month as, even though you may not see any immediate difference in your monthly payments, reducing the overall mortgage debt will bring down your payments the next time interest rates are recalculated.
Also overpaying now will more than likely give you a bit of leeway with the lender if you find it harder to meet regular monthly payments later.
All that said, it is still very important to retain some savings for a rainy day, so don't put all of your eggs in one basket - you're unlikely to be able to withdraw cash you pay into your mortgage later on.
Work out how much extra you can pay each month whilst still saving for a rainy day.
Alternatively, you could consider an offset or current account mortgage. These provide something of a halfway house in that they offset your current and/or savings account balance against the amount owed on your mortgage.
Current account mortgages treat your home loan like one big overdraft, by rolling your current account and mortgage into a single financial product.
As your lender will deduct the balance held in your current account from your outstanding mortgage debt before they calculate your interest payments, this gives you the opportunity to reduce the total amount you need to repay.
However, while your interest payments will go down as your current account balance increases, it's important to remember that the reverse also applies. Consequently, the amount of interest you need to pay will increase as your current account balance decreases.
Offset mortgages work on the same principle however, the positive balances in your current and/or saving accounts are held separately and then linked to your mortgage.
These flexible accounts aren't suitable for all homeowners, but they can be a good option to consider if you want to reduce your overall mortgage balance while still having access to your savings.
Early mortgage repayment is an option if you have a large amount of savings, making paying your mortgage off in full possible. This means that you then own the property outright. Obviously, this option depends on how big your mortgage is, what terms and conditions apply and how much you have tucked away in savings.
However, be sure to check your terms and conditions carefully before considering this route as you may be charged redemption penalties (usually a percentage of the amount you pay off).
It is also vital to balance the security you will get from owning your home outright with the need to retain some savings to offer a safety net if your finances take a turn for the worse.
Check the terms and conditions of your mortgage to see if a redemption penalty would be incurred, and how much it would be
Don't overstretch yourself; retain some savings for a rainy day
Again, there is no definitive answer here, but it is certainly something you should check out before doing anything.
Remember; as a rule, savings income is taxed (ISAs being the exception), whilst the money you spend on mortgage payments is not, so there is a potential tax benefit associated with paying off your mortgage, as opposed to putting your money in a savings account.
If you are unsure, check with an accountant to find out how your tax situation might be affected
Before you even think about overpaying or paying off your mortgage, it's worth considering the other options. Remember, even though the debt is usually very large, a mortgage is often one of the cheapest ways to borrow money.
Always aim to pay off your most expensive debts first
If you have a credit card, personal loan or even an overdraft, it is worth considering paying them off before you even think about reducing your mortgage arrears.
Credit or store cards in particular can often be the most expensive means of borrowing money, and personal loans are often more expensive than mortgages. Paying off expensive debts first will have a more immediate effect on your monthly finances.
As a general rule, the more expensive the debt in terms of interest rates, the greater the benefit you will get from paying it off quickly.
Check all of your debts to see which is the most expensive in terms of interest and start there.
Another option to consider is paying off any outstanding debts on your gas and electricity bills.
You don't pay interest on any outstanding balances, but your supplier will increase your monthly direct debit to ensure that any arrears are paid off over time - usually about 12 months. Clearing that balance will bring down your monthly payments, making you better off each month.
Check your utility bills to see if you are paying off any outstanding balances with your monthly payments
In summary, the question is always whether saving makes more sense for you than paying off debts - and it's a complicated question that must be considered properly (using expert help if required).
Think about whether a savings rate will make more money than you would save by paying off your mortgage or credit card.
A lot will depend on your individual circumstances, for instance the size of your mortgage and the interest rate you pay on it (bearing in mind that any interest you pay is taxable, whilst mortgage payments are not).
Consider this: £10,000 worth of mortgage debt at 5% interest will cost you £500 a year in interest. Tax-free, the equivalent amount in savings would earn you £500 a year.
However, if you are a basic-rate taxpayer this will decrease to £400 of interest earned on your post-tax savings each year. For higher rate taxpayers, the difference is even more pronounced with £10,000 in a 5% savings account offering a return of just £300 a year.
Compare this to the amount of interest you'll pay on your mortgage debt and, even if you only pay tax at the basic rate, you'd still be £100 better off by putting that £10,000 towards your mortgage.
Before paying off your mortgage or making an overpayment, check the terms of your mortgage to check that you are able to make a payment without being penalised. Most lenders allow you to make overpayments of up to 10% of your mortgage balance each year, however rules will vary depending on your lender and mortgage deal.
Once you are satisfied that you can overpay without a penalty, you can usually make an overpayment online or over the phone and get closer to paying off your mortgage early.
It typically doesn’t make a difference when you make an overpayment as for most recent mortgages, interest is normally calculated on a daily basis. However, if you have had a mortgage for a number of years and you aren’t sure when your interest owed is calculated, call your lender to check your mortgage terms.
Overpaying your mortgage can be hugely beneficial if you plan to remortgage, as it can help you reduce your loan to value ratio. Reducing your LTV can give you access to cheaper mortgage deals, as interest rates drop as your LTV goes down, which can save you thousands of pounds.
The current low interest rates on savings means that for many people, overpaying the mortgage is a better option than accumulating money in savings. However, it’s important to make sure that before you put your savings towards paying off your mortgage early, you have an emergency fund and you have cleared any expensive debt.
As a rule, if your mortgage interest rate is higher than the rate of interest paid on your savings after tax, putting your savings towards your mortgage is an option well worth investigating.
If you're a first time buyer or looking to move house or remortgage, we can help you find the best mortgage deal to suit your needs.