Overpaying mortgage vs saving then overpaying

[Chewsday]

I am currently overpaying my mortgage by £750 per month and can repay 10% of the remaining balance each year without penalty. Now that savings accounts are offering decent interest again should I look to pay my monthly overpayment into a savings account to make some money on the interest, then pay off a lump sum of the mortgage either every year or so or at the end of the fixed rate period?

I can’t work out how to calculate how much money I would save either way to compare options. 😬

Mortgage balance is £350k over the next 28 years and fixed at 1.09% for the next 4 years.

Anyone know how to work this out?

I like that my overpayment directly affects the capital in my remaining debt. I wouldn't know how to calculate it accurately but I love it means my regular monthly payments are chipping away and going further each time.

It isn’t a simple matter of whether the savings account There is a higher interest rate than your mortgage interest rate. you need a compound interest calculator which you can easily find online. Over paying the mortgage doesn’t just save you money on interest it also reduces your capital and thus reduces the interest you would be going forward because the capital itself is reduced. So to find out the real answer as to whether you’re better off saving or overpaying you need to use a compound interest calculator and plug in all the numbers because it isn’t a direct interest rate to interest rate comparison.

MSE mortgage overpayment calculator here to work out this exact scenario.

Simply input the amounts and the rates (mortgage and savings).

On a pure mathematical basis then putting your overpayments into any savings account with more than 1.09% for the next 4 years and then overpay later is best. You’ll benefit from compound interest whether in a savings account or by overpaying.

This does rely on being disciplined enough to actually sticking the overpayments into savings and not using them for something else though!

Do you have am emergency fund of 3-6 months of expenses?

If so then there is unlikely to be ay benefit in holding on to the cash before using it to overpay.

Top rate of savings is about 4.85 per cent so assuming this for next 4 years of a fixed rate mortgage at 1.09 you would make more saving 750 a month into that rather then paying it against the mortgage using your info into that mse overpayment calculator.

I didn't know you can overpay monthly and yearly?

Definitely check the MSE calculator, but it's daft to overpay on that rate.

However, you'll likely pay tax on interest you'll earn depending on your marginal tax rate so factor that in and possibly look at Premium Bonds and/or ISAs as they're tax free.

Yeah. It means you get more for your money because each payment there after goes further.

I’ve switched from overpaying to saving into cash isa with aim to use this at the end of the fixed period to pay a lump sum. At £750 a month, you will be well within the annual isa limit and will definitely find a Rate higher than 1.09%.

Assuming you don’t touch the interest earned, it will compound in the same way that the overpayments would in the mortgage and it is just about comparing interest rates. There are higher paying bonds but depending on existing savings, you may go into tax territory, hence I’m keeping overpayments in isas.

Over paying monthly or even weekly if they’ll allow will reduce interest further, at 1.09% that’s not going to save a lot of interest but it’ll depend what the loan is

the Interest on savings will depend on what your savings amount to, £5k at 5% saved in a monthly saver over a year is going to be around £130

overpaying has a limit though and 4 years of that limit will reduce the loan in 4 years time, which ultimately you will not pay interest on for 24 years at a higher rate, which over the life time of your mortgage will save you more than you’ll earn in interest on savings.

so the £750 = £36000 work out the interest that you will not pay on that amount at say 6% fir 24 years

Thank you all - food for thought.

I think I will open a 3 year fixed ISA and put the money I would have been overpaying in there instead. I will then use it as a lump sum when the fixed term ends. Should make a bit more on the savings than I would save in interest over that 3 year period. All helps to reduce amount of the loan left to be repaid when the current mortgage fixed term is up. This will also avoid tax implications on the savings interest too as yes I do have other savings.

This will also avoid tax implications on the savings interest too

Are you sure about that? (Or is that just because it’s an ISA?)

Yep the money that would have otherwise been going into overpayments will now be going into the fixed term ISA which will mean the interest there will not be subjected to tax.

I knew about the yearly, just didnt know you could do the monthly too!😀

Is this post just a humble brag about your mortgage interest rate and fix OP? 😂😂😂

Just kidding.

If it was me I’d be paying it directly onto the mortgage as I wouldn’t trust myself not to find compelling reasons to use the savings on something else.

@Chewsday. tbh if it was me and I had the option of savings, extra off mortgage or pension where I could pay in extra and save tax - id choose the later for 3 years.

Judging you have 28 years left on your mortgage your age id guess is under 40

so Id (with hindsight) buy extra pension for 3 years. If you put in £100 extra to your pension it'll cost you £70 and the government will give you £30, affectively. So putting in £750 would mean you'd save a considerable amount of tax - more than the interest on the savings you'd accumulate

Pension contributions are a good option but I suspect the OP might need / want a lower capital amount remaining in 10 years time.

So it’s a personal choice on their intentions down the line, do they want to move to a bigger house in the future? do they want to retire earlier?

ISA investing is a good balance between the two in my opinion. Pension returns are likely to be mathematically/financially better due to the tax relief and longer term of the pension investment (and that stock market returns generally beat property - but you can live in property) - but it can’t be accessed until age 57+.

do they want to retire earlier? being cynical the question maybe do you want to retire

Id probably split the funds

I wouldn’t go for a cash ISA just to avoid paying tax. The interest rates are pretty rubbish compared to normal savings accounts. There is a tax free savings allowance for interest each year and you’d probably be within that if you are a basic (£1000) or higher rate tax payer (£500).

Pension tax relief at basic rate is 20%, I.e. you put in £80 and it is topped up by £20 to £100

your mortgage is secured against your home and you should carefully consider prioritising other needs over it especially where you are taking on investment risk. Having said that, where you can get a much higher safe return in the meantime and then pay it off instead of paying a much higher interest when your deal comes to an end, it would make sense

mortgage interest does not compound, you only save interest on what you pay off

I'm probably missing something here, can I get your thoughts? If I don't overpay my mortgage it won't be cleared until my mid-60's.

So....as don't think I can afford to pay my mortgage as a pensioner, I must overpay my mortgage to reduce the term if I want to retire early.

Therefore, either putting money into a savings account and taking a chunk off my mortgage when the term ends, or overpaying my mortgage trumps putting that money into my pension.....?

Not necessarily because, assuming you pay tax, you benefit from tax relief in your pension.

So (just as an example and for round numbers) assuming you were a basic rate tax payer, and already had £300k in your pension pot, and had £100k to pay on your mortgage. You could pay £80k into your pension, benefit from the tax relief which would make it up to £100k in your pension (total of £400k in pension at this point), and when you retire take up to 25% (£100k in this example) as a tax free lump sum when you retire.

Thank you. I suspected that I was missing a trick

It’s not really that simple.

The tax relief is given once. If you don’t pay off your mortgage, you will be paying maybe now 5% per year in interest - it will cancel out your tax relief in 4 years.

With a pension, you take on investment risk - you may not get back what you put in. You can only take 25% tax free, the rest is taxable. And you can’t access your pension until 55 going up to 57.

Chances are, you will need your pension to provide you with an income in retirement.

Plus our chancellor is having to find billions. Pensions are one of the few government costs that could facilitate the eye watering cuts he will make.