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Should I use my savings to pay off my mortgage?

Written by Salman Haqqi, Senior Personal Finance Writer

27 November 2018

We weigh the pros and cons of using your savings to clear your mortgage.

Couple holding piggy bank outside house

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 what to do with your money:

There is more than one way to do it...

First, you can make regular overpayments on your mortgage (pay more than the regular monthly amount demanded by your lender). Most will allow you to do this without incurring fees, but many set limits on how much you can overpay. If you can, 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:

  • 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

Interest only mortgages

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.

But is it a good idea?

Well, as ever, that depends on your circumstances but it certainly can be.

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 off your mortgage later on.

  • Work out how much extra you can pay each month whilst still saving for a rainy day.

Offset and current account mortgages offer a half-way house

Alternatively, you could consider an offset or current account mortgage. These provide something of a half way house in that they offset your current and/or savings account balance against the amount owed on your mortgage.

Current account mortgages are those which 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 seperately 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.

Can't I just pay off the whole thing?

Yes, if you have a large amount of savings, you can pay off your entire mortgage in one go. Obviously, this option depends on how big your mortgage is, what terms and conditions apply and how much you have tucked away in savings.

Be careful to check your terms and conditions carefully before considering this route as you may be liable for 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

What are the tax implications?

Again, there is no definitive answer here, but it is certainly something you should check out before doing anything. Remember that, 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, instead of 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

Is paying off my mortgage the only option?

Before you even think about overpaying or paying off your mortgage, it's worth considering the other options. Remember, even thought 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

What about credit cards and overdrafts?

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 - what's more, dealing with those 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.

Are there any other debts I could consider paying off?

Another option to consider is paying off any outstanding debits 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

Do what is right for you

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 for instance - 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).

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.

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 tax payer this will decrease to £400 of interest earned on your post-tax savings each year. For higher rate tax payers the difference is even more pronounced with £10,000 in a 5% savings account offering a return of just a £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.

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.

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