With savings rates at rock bottom, putting spare cash towards clearing your mortgage early instead could be a wise financial decision.
Provided you don’t have other debts at higher rates of interest that should be tackled first, you could potentially shave years off your mortgage and save thousands of pounds.
What is the impact of overpayments?
There are several ways to do this. Say, for example, you have 10 years left on your mortgage and owe £50,000 on a home worth £150,000. If you’re on a rate of 2.59%, your monthly repayments would be £473. If you overpaid on your mortgage by £110 a month, giving a total monthly payment of £583, you could become mortgage-free two years early, and save £1,461 in interest payments.
When inflation is running high, it makes sense to borrow to reduce the value of debt over time. However, inflation hit an all-time low at 0.1% in February 2015, the lowest since records began in 1989, and is forecast to remain at this level for some time.
What is an offset mortgage?
Alternatively, you may want to consider an ‘offset’ mortgage. These use your savings to effectively cut your mortgage interest rate.
Say your mortgage balance is £150,000 and you have £50,000 in savings in a linked account, you only pay interest on the £100,000 difference. However, you could continue to make the same monthly repayments based on the full amount of your mortgage, so your balance reduces faster and you pay off your mortgage earlier.
You’ll give up earning interest on your savings, but you also avoid paying tax on this. You achieve the same effect as overpaying on your mortgage, but you can get the money back if you need it.
Watch out for charges
Often, lenders impose a minimum amount that you’re allowed to overpay. Many will let you overpay by up to 10% a year without penalty.
Also, beware of early redemption penalties for paying off your mortgage early, or going beyond the allowed overpayment limit. These may amount to around 3% of the mortgage debt – a massive cost if you’re not prepared. Check the fine print of your deal carefully.
Do you have more expensive debts to clear first?
Finally, remember that it doesn’t make sense to repay a mortgage at 3.5% if you have credit card debts where you could be paying 15% or more.
You also want to make sure that by focusing on your mortgage you’re not neglecting other financial needs. You should ideally have some savings set aside in an ‘emergency fund’ for a rainy day before piling every spare penny into your mortgage. If the boiler breaks or the roof leaks, you need money to sort this out.
If you clear your mortgage or only have a small amount left to pay on it but decide you need to access some extra cash, you could use equity release to unlock some of the capital in your property.