Homeowners with extra money to save have faced a new dilemma with sky-high interest rates.
Do they put the money into one of the major new savings accounts being launched? Or are they trying to pay down part of their mortgage to keep down the cost of their debt?
Many households developed a savings habit during the pandemic and are considering their next move.
Cunning move? Generally, you can overpay your mortgage by 10% each year without penalty. You simply need to contact your lender if you want to get started.
Here, Money Mail explains how to determine if overpaying on your mortgage is the best option for you.
Trick to reduce the costs of your mortgage loan
Not everyone knows that you can typically overpay your mortgage by 10 percent each year without penalty.
It is not complicated to set up payments. You simply need to contact your lender if you want to get started.
Most will generally allow you to overpay a single lump sum or increase your monthly payment.
If you don’t have expensive credit outstanding and can check the boxes on the dashboard, then it might be worth considering overpaying.
Makala Green, a financial planner at Schroders Personal Wealth, says: ‘In the past, mortgages were considered ‘good debt’, but with sky-high rates, they are actually becoming expensive debt.
“Those with low mortgage rates should think about lowering at least some of them before moving to a higher rate.”
The impact on your finances will be greater in the long run.
With mortgages, you inevitably end up paying considerably more than you borrowed, and the higher the interest rate, the higher your total bill.
For example, if you have 20 years left on a mortgage paying £250,000 at a 2 percent rate, you’ll end up paying £303,530, including interest, overall, according to the L&C Mortgages broker’s payment calculator.
Long-term benefit: With mortgages, you inevitably end up paying considerably more than you borrowed, and the higher the interest rate, the higher your total bill.
But if the rate were 4 per cent, you would pay £363,588 – a whopping £113,588 on top of your original loan.
Paying off more of the debt in the early years reduces the size of the loan on which interest is charged.
For example, if you paid an extra £200 a month for two years on that £250,000 mortgage at 2 per cent, you could save £2,184 in interest, according to analysis by Interactive Investor. This takes five months off the total term of your mortgage.
With the same overpayment and 4 per cent mortgage rate, you would save £5,339 in interest and shorten your mortgage by six months.
By overpaying early, you reduce the size of your debt, which in turn reduces the amount of interest you are charged.
If rates continue to rise, the more interest you’ll save by paying off your balance sooner.
Overpayment to unlock new rate
By overpaying your mortgage, you’ll pay down what you owe much faster and could qualify for a lower LTV when your fixed rate ends.
LTV is the value of a home compared to the amount you need to borrow when remortgaging.
This can unlock slightly lower rates. For example, Virgin Money offers remortgages 5.43 percent at 60 percent loan-to-value, compared to 5.94 percent for those who want 80 percent LTV.
Chanelle Pattinson, a financial planner at Money Means, says, “Lenders view lower LTV borrowers as less risky, so they may offer slightly more preferable rates.”
If you only have a few years left on your mortgage, the impact of overpaying will be less significant than if you start overpaying sooner.
You won’t qualify for better LTV deals, and the potential interest savings will be small. So if you’re nearing the end of your term, it may be more worthwhile to divert the cash into investments, pensions, or retirement savings.
Time Scale: If you only have a few years left on your mortgage, the impact of overpaying will be less significant than if you start overpaying sooner
How to calculate the key sums
Now for the key question: should you overpay the mortgage or save in a cash account?
First, check to see how your mortgage rate compares to the best savings deals on offer. Just as mortgage rates have risen, savings offers have also become more attractive in recent months.
Let’s say you have a 2 percent mortgage rate and you can get an easy access rate of 2.5 percent. If you put £200 a month into a savings account that pays 2.5 per cent, you would earn £117 in interest over two years.
By comparison, if you overpaid £200 a month for two years on a £250,000 mortgage fixed at 2 per cent, you would save £93 in interest over the two years, however this would amount to £2,184 at the end of the 20th year. -year of mortgage.
For the same mortgage fixed at 4 per cent, monthly overpayments of £200 over two years would save you £189 in interest, rising to £5,339 at the end of the mortgage term.
This means the interest savings could be much higher if you are forced to accept a higher rate in two years.
However, savings rates are not expected to rise as fast as mortgage rates.
Most major lenders have a mortgage payment calculator on their websites to calculate the numbers.
If you have a lump sum, the question is: do you pay part of the mortgage, or do you put it on a fixed rate that potentially pays 5 percent? With a balance of £5,000 paying 5 per cent over two years, he would earn £525 in interest.
If you had paid a lump sum of £5,000 on your 2 per cent mortgage, you would save £195 in interest over two years, according to L&C Mortgages.
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