Save by overpaying

DO you have a mortgage and savings? If so, it’s almost certain this is the moment to change strategy. Saving rates are dire are getting worse. So I want to urge you to urgently check now if you’d be far better off simply overpaying your mortgage instead – the gains can be in the £10,000s.

It’s now been over a month since the Bank of England cut UK base rates from 0.5 per cent to 0.25 per cent. Since then we’ve gradually seen savings account after savings account slash its interest – for example NatWest's cash ISA's has dropped to 0.01 per cent and Santander’s halving the interest on its 123 current account.

Of course, cutting rate is meant to benefit those with mortgages, yet millions are locked in on fixed rates, or paying over the odds, so for many there's little gain. That's why I’m calling on everyone with a mortgage and spare cash to check if overpaying it is their best form of saving.

There’s full detailed help at mse.me/mortgageoverpay, but here are the six key need-to-knows…

1 The big question – is your mortgage rate higher than the rate on your savings?

If it is then, quite simply you’ll be better off by overpaying it. It’s basic maths. For example, £1,000 saved at 1 per cent earns £10/yr. Instead use this cash to reduce a four per cent mortgage and your interest costs £40/yr less, so you're £30/yr better off.

And the compounded impact of this over years is enormous. Instead of saving, overpay £250/mth on a 20-year £150,000 mortgage at the current average standard variable rate of 4.8 per cent, and you'd clear the mortgage six years earlier, saving £27,000 in interest. That’s massive. I worked this out using the mortgage overpay calc at mse.me/mortgageoverpaycalc. You can put your own situation in there too.

However, if you're lucky enough to have a mortgage rate that's lower than your savings rate, don't overpay. Even though the calculator says you’ll gain, you’d gain more by saving.

2 Beware overpayment penalties.

Most mortgages allow you to overpay up to 10 per cent of your balance annually – even if you’re on a fixed deal. That’s a decent whack, but above it there are penalties. If you’re on the lender’s standard variable rate, overpayments are usually unlimited. However, if there are penalties, this will usually kill the gain from overpaying.

3 If you’ve other more expensive debts, pay them off first.

While a mortgage is likely to be your biggest loan, it might not be your most expensive. If you have other debt at higher interest, use any spare cash to clear that first, as it is costing you more.

4 Ensure you ask for the repayments to shorten the term.

Don’t let them just lower your future mortgage repayments, this effectively spreads the debt and means you don’t get as much benefit. When you overpay, ask it to keep your repayments fixed, which will effectively shorten the term of your mortgage, even if you’re making regular rather than lump sum payments.

However, please don’t read that as me saying “ask to shorten your term”. While cutting your mortgage term from 25 year to 20 years has the same effect as overpaying, you’re locked into it so can’t change back. By simply overpaying and letting that reduce the term gradually, you have flexibility to stop overpaying in future.

5 Always have a readily available emergency fund.

It’s important to have one of these just in case the worse happens. As even if you'd overpaid your mortgage, and, say you then lost your job, you could face mortgage arrears. So always keep an emergency cash fund to cover at least three and preferably six months of all bills. The only exception is for those with flexible mortgages allowing you to withdraw overpayments – as you could then do just that in the event of emergency.

Having said that, there are a range of bank accounts that offer savers high rates, up to 5 per cent or 6 per cent but only on smaller amounts. So as these are higher interest than most mortgages cost they’re winners anyway – and a good place to keep the emergency cash. Full best buys in mse.me/bestbankaccounts.

6 If you can, get a cheaper mortgage elsewhere.

If your mortgage rate is expensive, it’s always worth checking to see if you can get a cheaper one. Rates are at record lows at the moment – some are sub one per cent, so see if you can switch and save.

Overpaying won’t only help you save now, but may also help you to get a cheaper mortgage rate in the future. As it reduces your mortgage debt, it decreases your ‘Loan To Value’ (LTV - the per cent of the price borrowed against the total house value) ratio.

This is good as deals get cheaper each five per cent lower the LTV, down to 60 per cent. For example, the cheapest two-year fix at 95 per cent LTV is over three per cent, but at 90 per cent LTV it's under two per cent. On a £150,000 mortgage, that's more than £1,000 a year less.