Cut the cost of your mortgage
With banks offering very low rates for savers, is it time to start thinking of where else to put your money?
The possibility of the Bank of England raising interest rates is more probable now than it was a year ago. When rates do rise, the heavily expected 0.25% increase will have very little impact on your savings account.
So what else can you do? Well, if you have debts in the form of mortgages and loans, it makes sense to pay off your debts before saving money at a low return.
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After all, if the debt interest you are paying is higher than the savings interest you are earning – you are only costing yourself more money.
In recent years, low interest rates have driven many homeowners to overpay their mortgages.
Research from Barclays found 10% of British homeowners are currently overpaying their mortgage. With an overpayment of £200 per month on an average 25 year mortgage you could see your mortgage term reduced by seven years and three months.
Borrowers on a tracker rate and those on their lender's standard variable rate have seen their mortgage costs significantly drop in the last two years and may have extra money to play with.
So does overpaying your mortgage make sense? Well, the simple answer is yes. Even the smallest amount you overpay can add up to a large difference over the lifetime of your mortgage.
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How it works
The earlier you make the extra payments in your mortgage term, the faster your mortgage will be paid off. When doing this, you reduce the mortgage capital and also the compound interest on the debt
The additional payments will directly reduce the principal of the debt which will either reduce the mortgage term or the amount that you owe each month - because you owe less interest.
However, this will depend if your interest is calculated on a daily basis, if it is, then an overpayment will directly affect your interest. If your interest is calculated on a yearly basis, you will not see a change to your interest until the following year.
When you reduce the term of your mortgage you will save large amounts in interest payments that you would have been forced to pay if you had not made the overpayment.
The table below details how much money you could save if you were on a SVR of 3.99% based on an outstanding mortgage balance of £105,000 with a repayment period of twenty years.
| Monthly overpayment amount | Interest rate charged on loan** | Monthly repayment (Including overpayment) | Total repaid over lifetime of mortgage | Interest payment savings | Reduction in time taken to repay mortgage loan |
| £0 | 3.99% | £636 | £152,574 | - | - |
| £50 | 3.99% | £686 | £146,944 | £5,630 | 2 years 2 months |
| £100 | 3.99% | £736 | £142,526 | £10,048 | 3 years 11 months |
| £150 | 3.99% | £786 | £138,963 | £13,611 | 5 years 4 months |
| £200 | 3.99% | £836 | £136,025 | £16,549 | 6 years 6 months |
| * Figures based on an outstanding mortgage balance of £105,000, with a repayment period of 20 years remaining. Monthly costs are based on a repayment mortgage. ** SVR based on the current Halifax Standard Variable rate 04/04/2011. |
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As shown above, you could save large amounts of money and significantly shave years off your mortgage term. However, this assumes that interest charges are made monthly and the interest rate stays the same over the term of the mortgage.
Since interest rates will most likely go up this year, this will affect your standard variable rate which will cause these figures to change. However, you can still make savings by adjusting your overpayments with what you can afford.
Why now?
ISAs are a good vehicle for saving money, however, since interest rates are so low, overpaying your mortgage could prove to be a better option.
Remember, it’s worth overpaying your mortgage if the amount you can save on mortgage payments is greater than the return you can make from top savings accounts.
If you have secured a mortgage deal with an interest rate of 4% and your savings account is offering you 2%, it makes more financial sense to overpay a debt that has the higher interest cost.
Also, you will not be paying tax on the money you pay off your mortgage with, whereas the money you earn in your savings account is taxable – unless it’s in an ISA.
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What to look out for
One thing to note is that it’s not in your lender’s best interest for borrowers to overpay their mortgage. Remember, banks make money from the interest you pay each month so paying off your mortgage sooner will cause them to reduce the money they make from the loan.
This is why many lenders have limitations on what you can overpay so it’s important to check with your lender with regards to their overpayment policy.
Check with your lender that overpayments are allowed. Many lenders allow overpayments without charging early redemption fees. Some lenders depending on the mortgage deal you have allow you to overpay up to 10% per year.
If your lender calculates your interest daily ensure that it will reduce your mortgage and interest on the day when you overpay.
**This material is for information purposes only and should not be considered financial advice. We strongly encourage our readers not to rely solely on this content, but to seek independent advice when making financial decisions.**
Mortgages - YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON A MORTGAGE. FAILING TO ADHERE TO REPAYMENT TERMS MAY RESULT IN PENALTY CHARGES AND AFFECT YOUR CREDIT HISTORY. Rates may depend on your individual circumstances
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