Which? has crunched the numbers to see how overpaying your mortgage, saving and investing compare
Think carefully when deciding whether to overpay your mortgage or save (Image: Getty)
Which? has revealed whether it is always worth overpaying your mortgage – or if your spare cash could be put to better use elsewhere.
You could potentially save thousands of pounds in interest and knock years off your mortgage by making overpayments – but it isn’t always the right choice for everyone.
Which? has crunched the numbers to see how overpaying, saving and investing compare. The content from Which? is for informational purposes only and is not financial or investment advice.
Which? explains that if you had a savings account with the exact same interest rate as your mortgage, you would get identical returns.
But generally speaking, if your mortgage rate is higher than your savings rate, you would likely be better off overpaying your mortgage.
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Which? says investing is another option people often consider when deciding what to do with spare income – but this involves risk.
Analysis by investment platform IG shows that since 1999, UK stock market investors have seen around seven times the real return of cash savers after inflation.
However, there is always the risk that your investment could go down and any returns are not guarantee. Which? reiterates that if your investments perform poorly, you could lose money.
Should you overpay your mortgage or save?
Which? uses the example of someone with a £200,000 mortgage with 30 years left to pay and an interest rate of 5%.
If you made no overpayments, you would take the full 30 years to clear the debt. You would repay £386,512 in total and of that, £186,512 would be interest.
But Which? reveals that paying an extra £50 a month cuts two years and ten months off the term and saves you £20,924 in interest.
If this person overpaid by £250 a month, they would knock ten years and one month off their mortgage and save £70,796 in interest.
Which? then looks at what could happen if you saved £250 into savings or invested it.
Which? has calculated that if you invested £250 a month and achieved a 7% return, it would take 18 years and six months to build a pot worth £113,686, including £58,186 investment growth.
At that point, you could use your investment pot to clear the remaining mortgage balance in full.
Compared with making no overpayments at all, this would cut 11 years and 6 months off your mortgage term and reduce your interest bill by £36,128. But again, investing comes with risk and the returns are not guaranteed.
The best savings rates on the market are around 4% to 5%.
If you saved £250 a month with a 4% savings rate, Which? calculates that it would take 20 years and nine months for you to have a pot large enough to clear your mortgage.
This would reduce your mortgage by nine years and three months and save you £24,315 in interest.
Which? reiterates that your mortgage rate is likely to change over the lifetime of the debt, as will savings rates and investing returns. This will impact how much your term could end up being reduced by, as well as interest saved.
Reena Sewraz, Which? Money Expert, said: “When it comes to whether to overpay your mortgage, there’s no one-size-fits-all approach.
“Which route makes the most sense for you – making overpayments each month or choosing to save or invest your extra cash – will depend on your current mortgage deal, your tolerance for risk and your other goals.
“In most cases, it won’t make sense to consider overpaying your mortgage until you have a decent emergency fund in place, or if you’re trying to pay down other debts.
“Once those boxes are ticked, take the time to weigh up your options and compare the potential mortgage interest savings against how much your money could be making elsewhere.”
6 questions to consider first
1. Do you have an emergency fund?
You should ideally have at least three months’ worth of essential outgoings saved in cash for emergencies.
2. Do you have other debt you need to pay off first?
You should also make sure your other debts have been paid off first, or are at least under control.
3. Will you be charged to overpay?
Most fixed-rate mortgages you to overpay around 10% of your outstanding balance each year without incurring a fee. This varies by lender and deal so check your paperwork carefully.
4. Could overpayments improve your loan-to-value?
Lenders generally offer better rates on smaller loan sizes. So if you can reduce the size of your mortgage through overpayments, you may be able to secure a better deal when you come to remortgage.
5. Will you pay tax on savings or investments?
You may need to pay tax on your savings interest if you go over your personal allowances. Similarly, you may be liable for capital gains tax and dividend tax on your investments.
6. Is an offset mortgage worth considering?
An offset mortgage is a home loan where savings held in a linked bank account are subtracted from the amount of mortgage that you pay interest on. However, offset mortgages usually come with higher interest rates than ordinary repayment mortgages.