Deciding between earning interest on savings and overpaying your mortgage is a question I’ve been getting a lot recently. To make an informed decision, it’s essential to consider several key factors, including tax implications, interest rates, mortgage terms, financial goals, and more. As with all things money it will be personal, some prefer to take on risk, and leverage as much as possible, others feel calm and happy the quicker they pay off their mortgage. Personal finance is just that – personal.
In this blog post, I’ll explore these factors to help you determine the best course of action.
Interest Rate Comparison: Is Overpaying Your Mortgage Worth It?
Compare the interest rate on your savings account with the interest rate on your mortgage. If your mortgage interest rate is higher than the savings rate, overpaying your mortgage might save you more in the long term.
If you choose a savings account, tax needs to be paid on interest for higher and additional rate tax payers as follows.
- The Personal Savings Allowance (PSA) in the UK allows tax-free savings interest up to £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. For additional rate tax payers there is no tax free savings making it not as attractive.
- Any interest earned over your PSA is taxable, potentially reducing the net benefit of saving.
Mortgage Overpayment Limits: Know Your Boundaries
- Check if there are any penalties or limits on how much you can overpay on your mortgage annually without incurring charges. It is often 10% without penalty but check out your specific arrangement.
Mortgage Interest Type: Fixed or Variable?
- For fixed-rate mortgages, the interest rate remains the same, making calculations more straightforward.
- If you have a variable-rate mortgage, consider potential rate changes and how they could impact your decision.
Emergency Fund Considerations: Prioritise Financial Security
- Before overpaying your mortgage, ensure you have an adequate emergency fund.
- It’s typically recommended to have 3-6 months of living expenses saved but you choose whatever amount gives you peace of mind, for example if you know you want to have enough to also cover a broken boiler then put aside more for that
Long-Term Financial Goals: Aligning Your Decision
- Consider your long-term financial goals, such as retirement planning, investments, or other significant purchases.
- Align your decision to overpay or save with these goals.
Loan-to-Value (LTV) Ratio: Potential Benefits of Overpaying
- Overpaying your mortgage can reduce your LTV ratio, potentially leading to better mortgage deals when you come to remortgage.
Flexibility and Liquidity: Balancing Access to Funds
- Savings generally offer more flexibility and liquidity compared to overpaying a mortgage.
- Once you overpay, accessing that money can be challenging without remortgaging.
Impact on Credit Score: Demonstrating Financial Responsibility
- Regular mortgage overpayments can positively impact your credit score, showcasing financial responsibility.
Inflation Impact: Consider the Long-Term Effects
- Reflect on the impact of inflation on both your savings and mortgage.
- Inflation can erode the real value of savings more quickly than it affects fixed-rate debt.
When deciding whether to overpay your mortgage or save, or invest, it’s crucial to do what feels best for your risk tolerance. Where for some it is the best to invest in the stock market and just pay the minimun mortgage amount, for others the idea of losing that money on the stock market and not paying off their mortgage would be very uncomfortable. Everyone’s circumstances are unique, so it’s advisable to think about how it effects you and how you would feel in different scenarios.
By understanding the implications of interest rates, tax, mortgage terms, and your long-term goals, you can make a well-informed decision that aligns with your financial aspirations. If you’re unsure I can help you talk through your personal situation and coach you on the specifics. Check out Philly in your pocket here or other ways to work with me here