Is it time to whittle away your mortgage?
Given the average easy access savings account pays a measly 0.38% and inflation hit 2.7% in April, your cash has to work harder than ever to get a decent return.
And with the record low mortgage deals currently available, many borrowers may now be considering chipping away at their monthly mortgage payments to reduce the interest and term.
Below we speak to a finance expert and a mortgage expert to find out their views on whether now’s the time to throw any spare cash you have at your mortgage.
“Pay off any outstanding debt first” says Charlotte Nelson, finance expert at Moneyfacts
Savers have been hit by all angles recently and rising inflation is just a further blow.
With inflation eroding savers’ funds it’s little wonder they are looking elsewhere to put their cash to better use and overpaying on their mortgage could be just that.
Mortgage rates have reached record lows giving borrowers some extra cash to play with and this can be easily used to overpay the mortgage without much sacrifice.
With interest rates on savings accounts currently lower than interest rates on mortgages, this means that overpaying can be a good option for many. Savers are definitely fed up with the poor interest rates on offer in the savings market and the lure of being mortgage free is always attractive as it gives people peace of mind knowing that their home is safe.
In the long-run by overpaying, a borrower can shave years of their mortgage term and hundreds if not thousands of pounds in interest.
Rates are likely to go up at some point and with this in mind, overpaying now when mortgage rates are low can save any problems when rates do rise in the future.
Borrowers must ensure there are no penalties for overpaying their mortgage as any penalties that need to be paid can negate the benefit of overpaying.
Any borrowers with credit card debt may find they would be better off if they paid off this balance first as a higher interest rate will be applied.
This also applies to those who don’t have any emergency cash savings as you never know what the future holds. It’s always important to keep a pot for a rainy day as you never know what the future holds.”
“An alternative is an offset mortgage” says David Hollingworth of L&C Mortgages
Very low interest rates have hit savers hard, but the flipside is great news for borrowers with ultra-low interest rates available. Rising inflation may put the squeeze on monthly budgeting as the cost of day-to-day items like food and energy are pushed up, driven by the weaker pound.
Reviewing the mortgage therefore makes a lot of sense and can offer the chance to lock down the monthly payment on the single biggest outgoing as well as make some big savings in monthly payment.
Cutting the monthly payment may also help to open up further opportunities to make money work harder for the borrower and drive down the mortgage balance more quickly. Paying down debt can be a good way to employ spare cash rather than it sit on deposit at a potentially dismal rate.
Overpaying can be a good way to get a better effective return than in a savings account. Although the Personal Savings Allowance has changed things to a degree, the effective return on overpayments for those who would be otherwise taxed are enhanced. Overpaying on a mortgage rate of 2% would require the following gross savings rates to achieve the same return:
- Basic rate taxpayer: 2.5%
- Higher rate taxpayer: 3.33%
- Additional rate taxpayer: 3.64%.
Before making any overpayments it’s really important to check that your mortgage deal will allow it without charging a penalty. Most lenders will allow some degree of overpayment without incurring any early repayment charge, typically allowing up to 10% of the mortgage balance to be repaid without a penalty even during the early repayment charge period.
Some can be more flexible if that’s not adequate (eg Tesco Bank offers up to 20% per annum) and for those who really want the chance to make serious inroads into their mortgage, there are some deals that have no early repayment charges at any time.
Taking control of the mortgage payment and using that chance to overpay will not only help to cut the interest paid on the mortgage but also pay down the mortgage more quickly. That can not only help deal with potentially higher rates in the future as the borrower is not only used to devoting more of their monthly budget to the mortgage but they should also have a smaller mortgage to deal with when rates climb.
In terms of pitfalls it’s important to remember that overpaying on a traditional mortgage will not allow easy access to the cash if it’s likely to be required in future. As a result, it’s important to maintain a rainy day fund in cash and not throw every spare penny at the mortgage which could leave you short of ready savings to draw on.
However, an alternative option could be the use of an offset mortgage where the cash can be kept in a separate offset account but still cut the amount of interest paid on the mortgage. The cash still effectively earns the mortgage rate but the borrower still has easy access to it if they need.
That could suit someone who earns periodic bonus amounts that will be required as income at some point but in the meantime could be put to good use in cutting mortgage interest. Although this sounds like the best of both worlds it is important to be sure you will use the offset functionality as offset deals will typically come with a higher interest rate than a traditional mortgage, typically of at least 0.20% higher.
However Scottish Widows Bank currently offers an attractive two-year offset remortgage fixed rate through brokers at 1.19% to 50% LTV with a £749 fee.