Explain to me why it's better to not overpay on a low rate mortgage?

[Reallybadatdecisions]

I see lots of posts on here recommending to not overpay on a mortgage with low fixed rate and instead to put spare money into a savings account that earns more % interest then the mortgage.

I cant see how this makes financial sense but am willing to be corrected!

Eg

If my outstanding mortgage is very high (london prices) then im paying a big chunk of interest every month on that outstanding balance.

I dont have 100s of thousands spare to put into one high paying interest account so any interest I earn monthly in savings is pretty tiny in comparison to what I'm paying in interest each month on the huge mortgage.

So how is it better to not overpay?, I feel like so many of you have said its better to save then overpay that I must be missing something basic.

If you pay £100 off your mortgage that has an interest rate of 1% you save £1 per year

If you save £100 in a savings account that pays 2% you earn £2 per year

At the end of the year your wealth I.E. your mortgage Vs savings is either £1 or £2 better off

Psychologically it's hard to get past but it's purely maths around the respective interest rates.

Then the older you get the argument can be about putting money into a pension vs mortgage and using the 20%+ tax savings as another factor why a low interest rate mortgage is best left accruing whilst you save into a vehicle that gives you a leap ahead

@wobytide has explained it perfectly!

the interest you’re paying on your outstanding mortgage seems huge, but that’s because it’s on the entire amount owed. So if you can only pay off a little extra, the interest won’t go down by ‘a big chunk’ as you originally think.

using @wobytide example. If I had £100,000 left on my mortgage on a rate of, say, 1.5%, the interest you pay each month is for the entire £100,000 outstanding balance. If you can pay off £10,000 extra per year (10% allowance), you would be much better putting that £10,000 into a savings account earning around 4-5% interest than paying it towards to 1.5% mortgage. You would then pay all your savings as a lump sum at the end of your mortgage term (before you move to a higher interest rate).

All of the above. Also, if you use your pension as a long-term saving vehicle instead, you will have saved on a higher rate of tax that you are likely paying now vs. when you retire. You can then take a lump sum from that on retirement to use as capital on a property.

This. You have the same amount of money available whether you use it to overpay or save it separately.

If you overpaid a small amount, the interest charged would only go down by a tiny amount.

If you owe £200k and overpay £500, you then owe £199.5k and get charged interest on this amount instead.

But if you save the money instead, you still owe £200k, but you also have £500 in savings that you wouldn't have if you overpaid the mortgage.

And those savings earn interest at a higher rate than would have been saved if that money was paid off your mortgage. The advantage comes more clear if you keep overpaying and your savings grow.

It's like a self administered offset mortgage and is how we've always done it. For the last 15 years we had a low margin tracker so the interest charged was under 1%

We were getting 3-5% on savings so saved instead. Our mortgage was making us a profit because we had nearly as much in savings as our mortgage balance (mortgage tiny by MN standards as we bought years ago and our house does not meet MN expectations of size or location).

When rates rose and we could no longer get a higher rate on savings, we just sent all the savings to the mortgage account to reduce the balance. Because we've never had a fixed rate mortgage we could make unlimited overpayments

Numerous factors -

1. First the actual maths- plug numbers into MSE overpayment versus savings calculator and take guesswork out to decide yourself.
2. Second - will the money in savings end up getting spent/nibbled at for the “just this once”, or “we really need a treat” or “the boiler broke” type thing?

I take what I'd normally overpay and put it into a pension, that way I get tax relief and also the government top up on my pension. Plus it means that when I get my lump sum I'll be able to use some of that to pay off the mortgage when I'd have done so from overpaying - plus I get to keep the rest, and have a small increase of monthly pension. So it's a win win for me.

If your pension pot isn't raided

The pension thing again needs contextualising based on what it is exactly you are after. If you are overpaying heavily for instance to have a certain equity in your house by a certain deadline, which could be for any number of reasons, including two upsize, for example to a strategic area or otherwise, then having the money locked away in the pension is of no use if you need the equity in the house in your early 40s, for example to make a very significant upwards move.

there is really going to be a one size fits all answer to this. So as I said above, it is wise running the numbers through the overpayment of us are saving calculator to have actual figures on the table, but then contextualise it in the context of your own life, and the exact purposes towards which you are hoping to overpay/save/invest

Give your exact numbers, OP. Not many people are still on very low rate mortgages and savings rates aren't matching inflation, either.

Of course there's lots of people on very low rates. A year or so ago you could get 5 and 10 year fixed rates at 1-2%.

Plus inflation is irrelevant, while you have a mortgage you can overpay or save with the intention of overpaying later if comparative rates go against you as it affects your mortgage debt and savings in the same way.

We renewed our mortgage this year and got a rate of 3.99%. There are plenty of savings accounts with higher interest rates if we're prepared not to touch it for at least a year

Rubbish. Millions of people on 1-2% mortgages and savings now 4-5%

You need the MSE overpayment calculator https://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator/

It will do the comparison for you. I agree it's not always totally straightforward. I have two mortgages running and currently overpaying on the part that's fixed on a lower interest rate but it's a higher balance so has more impact on both the amount saved and - importantly for me - the term.

However a decent cushion of savings is good before you start overpayment. I have the best rates on balances up to 5k (often need current account with same bank) so I've made the most of these but I'm putting the interest made into the mortgage as once the balance goes over 5k you get next to nothing on the excess.

You also need to check the conditions of your mortgage. Mine will allow up to 3x the monthly payment but less as a lump sum.

Can you explain what is meant by this? Who would raid a pension pot?

Where are the 4-5% savings accounts?
If you overpay your mortgage now you can take years off it for the future. I won't be able to afford to do that when the mortage interest rates rise for me, so I am doing it now.

Plenty of places offering 4-5%, especially if you fix for a year or two.

You can also take years off by saving separately, more years than just overpaying now.

It's basic maths if your mortgage rate is lower than the saving rate.

Don’t forget to factor tax in, though, when you do your calculations. You need to compare your after tax interest on a saving account with the mortgage rate. Depending on circumstances, the tax on the interest could be anywhere from 0-60%.

Thank you all. We've run the calculation and we are better off saving. Thank you for explaining, much appreciated.

Or do both? We paid off a chunk recently as our rate was rising and it was very satisfying to actually see the amount come off the capital. However, we also set up a 4.75% savings account and are going to split between the two at the start of each month.

Gordon Brown started it. George Osborne doubled down. Labour have said they will reverse the changes from the last budget in terms of Lifetime Allowance and Annual Allowance.

My mortgage is fixed for 5 years at 1.99%.

The savings I've got with Nationwide earns 4%.

Much better to save it until such time as it is a decent amount to reduce/clear mortgage.

Gordon Brown started it. George Osborne doubled down. Labour have said they will reverse the changes from the last budget in terms of Lifetime Allowance and Annual Allowance.*

How many people are affected by LTA and Annual Allowance changes as a percentage?

And given the original quote about pensions being raided was on the fact that 20%+ is from the tax savings it takes a lot for anyone to be losing out even when rules change