Is it time to overpay your mortgage?
Savings rates are dire – is it time to overpay your mortgage? Our Money Saving Expert Martin Lewis today launches a clarion call for everyone with a home loan to see if they can cut its cost…
It’s now been a month since the Bank of England cut UK base rates from 0.5% to 0.25%. Since then we’ve gradually seen savings account after account slash its interest – for example NatWest's cash ISA's has dropped to 0.01% and Santander’s halved the interest on its 123 current account.
While the cut was meant to benefit those with mortgages, millions of you 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. Here’s the five key need to knows…
The big question – is your mortgage rate higher than the rate on your savings?If it is then it’s worth overpaying it – for example £1,000 saved at 1% earns £10/yr. Instead use this cash to reduce a 4% mortgage and your interest costs £40/yr less, so you're £30/yr better off. Overpaying your mortgage can add to thousands saved, for instance using Martin’s ‘Mortgage overpayment calculator’ shows overpaying £250/mth on a 20-year £150,000 mortgage at the current average standard variable rate of 4.8%, you'd clear the mortgage six years earlier, saving £27,000 in interest. That’s massive.
Yet if you're lucky enough to have a mortgage rate that's lower than your savings rate, don't overpay. Of course there are bank accounts which pay high interest – 5% or 6% on smaller amounts – which generally will be better than paying off a mortgage, so use those first.
Beware overpayment penaltiesMost only allow you to overpay up to 10% of your balance annually – though that’s usually a decent whack, after that there can be penalties. Yet if you’re on the lender’s standard variable rate, overpayments are usually unlimited. Either way check first.
Ensure you ask for the repayments to shorten the termDon’t let them just lower your future mortgage repayments, this effectively spreads the debt and means you don’t get as much benefit.
Always have a readily available emergency fundIt’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 high interest accounts above are great for this). 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.
5. If you can, get a cheaper mortgage elsewhereRather than just overpaying, see if you can slash your current mortgage rate first. Rates are at record lows at the moment – some are sub 1% so see if you can switch and save. Like Kperat, who emailed"Fixed at 1.24% for 2 yrs, and reduced term to 13 yrs[effectively overpaying - ML] without paying more a month. Will be saving about£20,000even after fees. THANKS.”
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 % of the price borrowed against the total house value) ratio. This is good as deals get cheaper each 5% lower the LTV, down to 60%, eg, the cheapest 2yr fix at 95% LTV is over 3%, but at 90% LTV it's under 2%. On a £150,000 mortgage that's over £1,000 a year less.