Should I save or overpay my mortgage?

You don’t need to overpay by a huge amount each month for it to make a big difference.

Typical houses in suburban London (Twickenham)

If you’re lucky enough to have built up your savings over the past year, you might want to consider overpaying your mortgage so you can reduce your mortgage term by months or even years.

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Lockdown measures over the past 16 months have restricted our ability to spend, which has boosted many people’s savings. According to the latest Wealth and Wellbeing Monitor from LV=, in June 2021- 18% (9.5m) UK adults said their incomes had increased over the past three months – the highest figures since the quarterly survey started in June 2020.

Unfortunately returns on savings accounts are exceptionally low at the moment, which means using some of your savings to overpay your mortgage may be worth considering. Make sure you always have a savings buffer available though in case of any unexpected expenses.

A spokesman for financial website Moneyfacts.co.uk: “You could be paying out more than double in interest each month than you can earn from your savings accounts. If your savings earns less interest than the amount you pay on your mortgage, then you will save more money by using these to pay-off your mortgage balance.”

You don’t need to overpay by a huge amount each month for it to make a big difference. Even overpaying £50 or £100 a month can save you a significant amount of interest and reduce your mortgage term substantially.

Brian Murphy, head of lending at the Mortgage Advice Bureau said: “As mortgage interest accrues on the full amount of your mortgage over its entire term, consider overpaying to reduce the amount on which interest is charged. Doing so may help not only pay off your mortgage debt faster, but also be a big money saver in the long run.

“For example, if you have a £100,000 mortgage over 25 years with an interest rate of 4%, and you pay off an extra £100 a month, you could reduce your mortgage term by six years and save £15,534 on interest. Keep in mind though whether you can overpay on your mortgage without a penalty. A 10% overpayment facility per annum without incurring penalties is fairly typical of many products.”

Those paying a higher rate of interest on their mortgage, as in the above example, will see bigger savings by overpaying than those on more competitive rates, but there are still big benefits for those on much lower mortgage rates.

For example, a homeowner with the same £100,000 mortgage but on a fixed mortgage rate of 1.19%, making £100 overpayments each month would still pay £3,748 less in interest over the 25-year term and reduce their mortgage term by five years and 10 months.

Another benefit of making overpayments is that you can stop, start, increase or reduce your overpayments at any point, so if your finances change you can adjust your overpayments accordingly. Bear in mind though, that if your financial circumstances change, you can’t decide you want this money back, which is why it’s vital to keep some savings readily available.

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