Pay Down The Mortgage Or SavePosted on: 29 November 2007 by Gareth Hargreaves
What should you do?
Does overpaying your mortgage make more sense than saving in a deposit account? If you've cash to spare at the end of the month, should you make every effort to reduce the repayments on your home loan, or would you be better putting the extra in a savings account? The usual rule is to get rid of debt before you start to save. Statistics show that overpaying £50 a month on a 25-year £100,000 loan at 5.75% would save you more than £15,000, and reduce the term by 3.7 years. But should you always do this?
Certainly you should always get rid of credit card debt as soon as possible because it is a ruinously expensive way to borrow. But mortgages are slightly different.
Unfortunately there is no easy answer and which is best for you will depend on a number of factors including prevailing interest rates, your tax rate, the terms of your mortgage contract and whether you need easy access to your cash. But don't despair. There are a number of pointers to help you decide what to do if you receive a windfall or a payrise and you find yourself with surplus funds.
First, you should always retain an emergency fund of ready cash . Three months' salary is a good guide to how much you should keep liquid for unforeseen purchases such as car repairs or urgent home maintenance. You might argue that you have spent most of your life overdrawn without this much cash to spare, so why does this matter now. But when you are lucky enough to have extra funds, the idea is to maximise the advantages, not to return to your old bad ways, incurring overdraft charges and late payment penalties which outweigh the savings you could be making. Look for the highest rate instant access savings account you can find for your emergency fund.
If you are thinking of reducing your mortgage then you need to consider the terms of the mortgage contract - whether you are allowed to make overpayments. Most fixed-rate deals will restrict how much you can overpay. Some will dictate that you may overpay nothing at all, but many will allow up to 10% of the capital outstanding each year. Check what your terms are. There is precious little point trying to make the best of your money by reducing debt, but actually incurring penalty charges in the process.
One of the times you should definitely consider overpayments to your loan is if you have a flexible or offset mortgage when you can "borrow back" overpayments in an emergency. This takes care of the need to have access to liquid funds, but also allows your money to work for you by reducing debt when you don't need to have your hands on the cash.
If you think you can make more money by putting your excess funds on deposit than reducing your loan, you need to consider how much you would receive from a savings account compared with how much you could save by paying down your mortgage.
Don't forget that looking at headline rates can be misleading because how much you will receive from a savings account will depend on your personal rate of tax. If you are a higher rate taxpayer you are going to lose 40% off the gross interest.
If you are lucky enough to have a low fixed rate mortgage and can go for a high savings interest rate, this is a route you could consider. Among the highest savings rates are those on regular savings accounts.
Skipton Building Society is paying 7.55% in its Christmas Saver and Leek United Building Society is paying 7.5% on its regular savings account, both with minimum monthly payments of just £10.
There are also some excellent deals tied to bank current accounts such as 12% gross attached to Alliance & Leicester's Premier current account. But it is rarely worth switching your account just to get the better deal. You need to be absolutely sure you can keep to the terms and conditions of the current account and you should only switch if it is your current account you want to change.
One reason you might want to opt for a savings account compared with paying down your loan is to take advantage of tax-free savings in an individual savings account . You can put £3,000 into an ISA each year on a "use it or lose it" basis. If you miss a year, you can't make it up later. Having a tax-free cache can be useful so you might want to delay making overpayments to your loan until your or spouse's ISA allowances for the current year have been exhausted.
Finally, if you are among the less well off, and you receive a windfall you should consider how putting money into a savings account might affect benefits or grants. Interest on savings counts towards income and can affect anything from council tax benefit to free prescriptions and assistance with children's university fees. If your situation takes you to the cusp of any of these benefits, make sure you consider any impact on them before you decide what to do with your money.
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