Should you use your savings to overpay your mortgage?

Early mortgage repayments could be a better way to save in a low interest-rate environment, says Ruth Jackson-Kirby.

Stock people looking at things
Making an overpayment is easy, but check your mortgage terms first
(Image credit: © Getty Images)

If you have excess savings and interest-bearing debts, it will almost always make sense to use the savings to pay off the debts. To see why, assume you have £1,000 in an account earning 0.7% interest, but you owe £1,000 on a credit card at 19.9%. Over a year you would earn £7.02 interest on your savings, but you would pay £93 interest on the credit card even if you paid off £100 a month. So the most profitable option is to use your savings to clear the debt and avoid the £93 interest.

The only form of debt that most sensible savers may leave unpaid while also keeping a substantial cash balance is mortgage debt. Mortgages are a long-term loan with a comparatively low interest rate. The amount you lose from the difference between mortgage interest and savings interest can be relatively small. Many people will feel that it’s outweighed by the flexibility and security that comes from building up cash savings.

However, an increasing number of people now seem to be running down savings to make overpayments on their mortgages. In the first six weeks of 2022, mortgage payments were 50% higher than last year, according to Santander. And it’s easy enough to see why that is.

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Someone with a 25-year £200,000 mortgage on a 2% rate who overpays by £100 a month would pay off their debt three years faster and save £7,642, says Santander. Given that the average five-year fixed-rate mortgage is currently 2.7% according to MoneyFacts, while the average notice savings account now pays around 0.6%, that two percentage-point spread is fairly realistic.

The added benefit is that overpaying should get you a better deal when you want to remortgage. You will have a lower loan-to-value (LTV) ratio, which should mean you are offered lower rates.

Overpay your mortgage now, reap the rewards later

However, there are some things you should consider first. Assess whether you can afford to make an overpayment. Once that money has gone into your mortgage, you can’t get it back, so ensure you have enough money in your emergency savings first. It’s wise to keep six months of your salary in an easy-access account for events such as a broken boiler.

Next, check your lender’s rules are on overpayments. If you have a fixed-rate or discounted-rate mortgage, then it is likely to have early repayment charges that could be triggered by overpayments. These charges would easily wipe out any interest savings.

However, many lenders allow you to overpay as much as 10% of your outstanding debt each year. If you are on a variable-rate mortgage you may be able to overpay more. You can usually make overpayments by increasing your monthly direct debit or by making one-off transfers.

Ruth Jackson-Kirby

Ruth Jackson-Kirby is a freelance personal finance journalist with 17 years’ experience, writing about everything from savings accounts and credit cards to pensions, property and pet insurance.

Ruth started her career at MoneyWeek after graduating with an MA from the University of St Andrews, and she continues to contribute regular articles to our personal finance section. After leaving MoneyWeek she went on to become deputy editor of Moneywise before becoming a freelance journalist.

Ruth writes regularly for national publications including The Sunday Times, The Times, The Mail on Sunday and Good Housekeeping, among many other titles both online and offline.