During this Mortgage crisis it makes financial sense to overpay your mortgage rather than accept a low return from your savings account
The question of whether to over pay your mortgage or accept a low return on your money invested is an importance issue in today’s economic climate. As a money saving expert, I will explain how you can save thousands of pounds by over paying your mortgage and why it is more tax efficient than saving money in the bank or building society if you have a mortgage.
As the Bank of England drives down interest rates in an attempt to control deflation; savers are left earning a pittance from their savings whereas some mortgage borrowers are saving hundreds of pounds in reduced mortgage payments each month. Borrowers on Tracker rate and those on the Standard variable rate mortgages have seen their mortgage costs drop drastically in some instances and they now find themselves with extra money in their pockets. The Co-operative Bank Mortgage lending department recently revealed that they had seen a 50% increase in mortgage borrowers making overpayment into their mortgage accounts.
What the Co-operative Bank discovered
The Co-operative bank conducted a poll of 1000 adults from their bank to expose some of the reasons why borrowers were overpaying their mortgages. It revealed that 80% of those polled declared their reason for overpaying their mortgage was due to low returns on their savings accounts; some 37% choose to pay extra money off their mortgage due to the reductions in the base rate; whilst 24% of borrowers were choosing to disregard the recession and spend their surplus money on clothing and holidays. The Co-operative bank said it appeared that customers were recognising the benefits of making overpayment in light of the historical low interest rates being paid to savers at present.
Flexible Mortgages are the Future
Some mortgage lenders will not allow overpayments, while other lenders would allow a maximum of five or ten percent overpayment each year. Other lenders like the Co-operative bank and the Northern Rock will allow their borrowers to overpay larger amounts off their mortgage balances each year. In the case of the Northern Rock they will allow the borrower to overpay the whole amount to within £1 of paying off their mortgage without incurring any penalties for making large overpayments. These types of mortgage accounts are called ‘flexible mortgages’ as they allow the borrower to overpay, underpay and borrow back the overpayments already made. Flexible mortgages put the borrower in control of their mortgages.
It makes financial sense!
It makes real financial sense for mortgage borrowers to make even small monthly overpayments, as these overpayments can add up to a large difference over the lifetime of the mortgage. By making an overpayment you will reduce the amount of the mortgage outstanding and if you continue to over pay you will also reduce the term of the mortgage. By reducing the term of the mortgage you will save enormous amount of money in interest payments that you would have otherwise paid if you had not made any overpayments.
Better Interest rate than a Savings account
Many people are overpaying their mortgages due to the low returns received from their savings accounts and the higher costs of their mortgages. If you are committed to a mortgage with an interest rate of say 5% and your savings account is offering you 1%; then it is advisable to overpaying your mortgage debt that has the higher interest cost. The sooner you can pay off a higher interest rate debt the cheaper the debt becomes and the more money you will have saved.
Tax efficiency
By far the best reason for paying off your mortgage rather than saving the money in a savings account is that you will not pay any tax on the money you pay off on your mortgage. Where as the money you earn on your savings account is taxable at 20% at source by Inland Revenue and if you are a higher tax payer than it will cost you a further 20%. So for a higher rate tax payer the benefits of overpaying your mortgage are substantial more cost effective and it is just as cost effective for lower rate tax payers.
It’s not in your Banks Interest for you to overpay your mortgage.
It’s not in a banks interest to see its borrowers overpaying their mortgages. Banks make money from the interest you pay them each month. So they do not want you to pay your mortgage off any quicker as they will lose money. This is possibly one of the main reasons that many mortgage lenders have limits on the amount of overpayments they will allow. Don’t ever believe your bank cares about you they only care about satisfying the needs of their shareholders. The longer the duration of your mortgage the more interest you will pay the bank; for example a 25 year mortgage will earn the bank more money than a 20 year mortgage. For external reviews and comparisons, please take a look at mortgage lenders
Your thoughts, experiences and comments are welcome. You can join this discussion below and leave your thoughts and experiences.
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Great article! This strategy also applies to other loans like student loans. My girl friend asked for a student loan of about $20,000. Debt kept climbing while she was studying and by the time she graduated her total Debt was around $25,000. She started to work about a year and a half ago. The monthly payment that was asked from the bank sat around $200 monthly but she started to pay $250 or more every time she made a payment. She received a letter a few weeks ago from the bank with a new monthly payment rate of about $130 and a lowered interest rate. I assume that since things are not going well for banks during the financial crisis, they try to avoid overpayment. This way they get more money in the end but if in her case, the bank was forced to create a more comfortable payment plan to see if she takes the bait and pays only the money that she is “supposed to”. What she is doing is burning a hole in the outstanding balance. Ironically, her lender is Wachovia one of the big banks in the US that is almost dead due to the financial crisis.
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[...] any savings is a maximum return of 1.5% per year – this is appalling and outrageous! So why not over pay your mortgage which will be on an interest rate of 4% to 7% depending on your mortgage deal. By overpaying your [...]
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I found your blog from one’s of the bookmarking sites. It’s so interesting to read your post. I will regularly check your site. Thanks
I’m seldom to write a comment from a post that I read. But this article is really good so i can’t just leave this site without giving this comment.
I found your blog from one’s of the bookmarking sites. It’s so interesting to read your post. Usually I don’t like to make a comment, but I can stop my self to made a comment here. I will regularly check your site. Thanks
It sounds like you’re creating problems yourself by trying to solve this issue instead of looking at why their is a problem in the first place
Thanks for your information!
i recently worked out it is possible for me to pay off my mortgage in less than five years if i continue to overpay my mortgage at the current rate. early retirement is a great incentive for me to overpay….
hello,
Thank you for the great quality of your blog.
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Just read your article, Mark, and makes good sense. Keeping savings earning next to nothing at current savings interest rates is not a smart thing to do. As you say, far better to use any affordable surplus to chip away at the capital!
The ability to manage your personal finance is key for successful long term financial fitness and stability. Regardless of how much you earn, being able to make your income work for you is essential. Not everyone requires a large salary and an expensive home and car to be happy, but they do need to be comfortable in terms of being able to eat and sleep in a healthy environment, and provide adequate clothing and shelter for their families as well.