Got a mortgage? Overpay if you can!

Low interest rates may mean savers are suffering, but there are ways to use rock-bottom rates to your advantage.

If you have a mortgage, one of the best ways to ensure your money works as hard as possible for you in today’s low interest rate environment is to overpay your mortgage.

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Rather than earning paltry returns by stashing your cash in a miserly savings account, overpaying your mortgage could knock thousands of pounds off your overall interest payments, and mean you pay off your home loan early.

Benefits of overpaying

According to research by MoneySuperMarket, someone paying the average standard variable rate of 4.38% could slash almost £10,000 off their £100,000 mortgage over three years simply by overpaying £250 each month. Without overpayments, their mortgage balance would be £84,877 after three years, but with overpayments, it would be £75,277, a difference of £9,600.

If the same £250 was paid into a savings account with an average annual equivalent rate (AER) of 0.45%, the total amount of interest earned would be £313.58. However, once tax is deducted, a basic rate taxpayer would be left with £252.86, while a higher rate taxpayer would end up with just £188.15.

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The longer you overpay, the bigger the benefits

If you can afford to overpay your mortgage over a longer term, you can watch your mortgage shrink even more. For example, overpaying by £250 a month over a 15-year term would save you an attractive £12,242 in interest alone and cut four years and eight months off your mortgage term, meaning you could pay off your home loan in full in just over a decade.

However, if you put the same amount into a savings account paying 0.45% over those 15 years, you’d end up with a total balance of £47,336.56, which includes a paltry £2,335.65 in interest. Overpaying your mortgage would therefore leave you £22,010 better off over 15 years than if you’d put your money into a savings account.

Clare Francis, mortgage expert at MoneySuperMarket, said: “With interest rates set to remain low for at least the next three years, it’s a great time for mortgage borrowers. Not only can they benefit from the lowest mortgage rates in history, but they can also reduce the negative impact of low savings rates by channelling spare cash into the mortgage instead. Regular overpayments will help reduce the amount you owe, reduce the amount of interest you will pay over the term, and lead to you being mortgage-free sooner.”

Overpayments aren’t right for everyone

Although making overpayments can save you thousands over the course of your mortgage, this route won’t be right for everyone, as once your money has gone into your mortgage, you won’t usually be able to get your hands on it again.

Clare Francis warned: “It’s important to think about the implications beforehand. While the benefit of keeping the money in a savings account may not be as great from an interest perspective, as least you retain easy access to that cash in case of an emergency. Once you’ve overpaid on your mortgage, while not impossible, it is much harder to get at that money again. Opting for an offset mortgage can be a good way around this as you can benefit from overpaying while being able to get at your savings at any time.”

Offset mortgages work by matching-up your savings against the amount you owe on your mortgage, so you only pay interest on the difference between the two. Lenders offering offsets include Yorkshire Building Society and First Direct.

Brendan Gilligan of Yorkshire Building Society said: "We have been providing offset mortgages for more than a decade but many people still think the product is complicated or they need a lot in savings to make a difference, when neither is true.

"Offset gives you a similar benefit in terms of bringing down your monthly repayments, or reducing your mortgage term, but with the added flexibility of retaining instant access to your savings should you need them later.”

Remember that, depending on which kind of mortgage deal you have, there may be restrictions on the amount you can overpay on your mortgage. For example, some mortgages only allow you to overpay a maximum of 10% of your home loan each year before imposing a financial penalty, so you’ll need to check with your lender before you change your monthly payment.

Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct

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