Instead of overpaying the mortgage, pay into a savings account

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So, if my reasoning is true, if a savings account pays a higher interest rate than my mortgage, I’m better off paying into the savings account rather than overpaying, right?

I owe the bank £200,000k on a four-year fixed-rate loan at 1.5%. So I’ll pay (approximately) £3000 in interest every year. If I overpay by £10,000 in the first year, I will save £150 in interest every year (for as long as the rate remains constant), because my debt will be £10,000 smaller than it would have been otherwise, every year from now on.

However, if I earn a 2% return on a savings account and deposit $10,000, I will receive £200 in interest. Profit of £50.

Then, when my fixed rate expires in four years, if my interest unexpectedly jumps to 5%, I can take all of that extra money + interest in my bank account and pay off a large portion of my mortgage (no longer in a fixed rate and thus able to overpay with no limit). Instead of overpaying the mortgage, pay into a savings account

Does this reasoning make sense? In addition, I’m thinking of interest rates as annual when they’re actually monthly. Is my logic still valid if we’re talking about £833 per month instead of £10k per year?

CANDID ADVICE

Right on. Because interest is calculated daily, your logic applies to any time frame.

Keep an eye out for taxes on your savings. If you exceed your personal allowance, you will be taxed on some deposits, essentially lowering the interest rate you receive.

Is it right to assume that my allowance is £1000 of total interest if I earn £48k per year? So, at 4% interest, I could save up to £25k without going over?

As soon as interest tax becomes a consideration, an ISA may be the answer – providing you are not taking a rate much lower than outside the ISA wrapper or utilising your ISA limit otherwise.

This is accurate. I took some additional equity and deposited it in a 2.75% savings account. Depending on what happens with the government in the coming weeks, these will be 4%.

It will reach close to 5% by next year regardless of what the government does. What they do can influence how quickly and whether it gets over.

To clarify, what do you mean by “additional equity”? Did you increase your mortgage or simply return money you had already overpaid?

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One more thing:

Increasing the amount of capital in your mortgage reduces the LTV. Reduced LTV may allow you to get a better rate on your entire mortgage. The cut-off points for lower interest rates are typically set at 5% increments.

However, if you have a wonderful fixed rate, this only applies when it comes time to re-mortgage. To say the least, remortgaging now is unlikely to result in a higher rate.

So, generally, simply save, and then when it comes time to re-mortgage, assess if increasing your deposit would result in a substantial rate improvement or not.

I remo’d in the middle of a shitstorm, and the variations were only 0.25% across the full range of 60% to 90% LTV. I’d rather have the cash in hand, and I factored that into my decision (along with the 40% tax on the interest).

Yes, simply calculate based on whichever percentage is greater, albeit depending on the amount of overpayment and income levels, you may need to consider tax implications.

Several points should be made.

Money in your savings account might be used for any unexpected expenses. Car write-offs, for example. Any money put into a mortgage will be more difficult to withdraw.

However, how disciplined are you when it comes to saving money? Can you leave it without spending it?

Personally, I’d rather the money be gone than in an account where I can wind up spending it on frivolous things.

Does this suggest that when your existing fixed rate expires, you will allow it to revert to your lender’s regular rate? Or are you claiming you’ll have paid off your mortgage in four years? Instead of overpaying the mortgage, pay into a savings account

When does the ‘no-limit’ rule apply? 

Sorry if that was a stupid question; I’m still learning about all of this.

After the fixed rate period expires, early repayment penalties cease, allowing you to take another fixed rate agreement, switch lenders, or pay off a substantial portion (or even all) without penalty.

The no limit applies after my set term expires but before I accept another fixed term. So, on the 10th, my fixed term expires, I overpay as much as I can/want on the 11th, and on the 12th, I accept a new fixed rate on whatever I still owe.

I believe you should mention the tax implications. I know it’s stated elsewhere on that page that mortgage overpayments are tax-free, but I don’t think it’s clear enough when you say “simply compare the rates” that you should compare the rates after tax.

I also don’t think it’s made obvious enough that you can overpay between fixed terms by using savings. This isn’t obvious on the other mortgage pages, either (unless I’m missing where it’s specifically stated).

Put your numbers here and see whether they match up with reality: https://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator/

Although the interest rate on the current account is greater, by overpaying you actually save more throughout the life of the mortgage.

Overpaying by £10k per year for £200k at 1.5% clears the loan in 11 years and a bit and saves you roughly £22k in interest. £10k invested in a 2% savings account for 11 years yields £13k in return. So you “save” an extra £9k by overpaying instead of saving. (Assuming no changes in interest rates, etc.)

What you haven’t considered is that a tiny proportion of a large number can be greater than a large percentage of a small number. Mortgage interest is also computed daily, so the faster you pay it in, the more you save, whereas bank interest is paid at the end of a term (month or year), so the compounding effect in saving vs mortgage is much smaller.

You must also consider any taxes you would pay on savings interest that you do not have on mortgage overpayments. To be better off saving as a basic rate payer, you would need an interest rate of roughly 3.2%. It would be 4.5% as a higher rate payer. Instead of overpaying the mortgage, pay into a savings account

Overpaying by $10,000 clears the loan in 11 years, saving me $22,000 in interest. Saving $10,000 every year for 11 years earns me $13,000 in interest. So that’s $9,000 less. But I still have £110,000 in savings:P According to your calculations, I’m £101k richer.

My friend, you’ve completely muddied the numbers. The aim is to deposit money into a savings account earning a higher interest rate during the fixed term, and then utilise the money in the savings account to pay off the mortgage when the fixed term ends.

Please accept my apologies in advance if this is a foolish question:

You have four years left on a fixed mortgage, which means your monthly payment will remain the same. To simplify things, suppose your monthly mortgage payment is £500, which includes £400 in interest and £100 in capital payments.

You now make a lump sum of, say, £10,000. We have the numbers for what you would gain from a 2% savings account over this time period, but are people taking into account that you have unwittingly boosted your monthly capital repayments? 

So, in addition to the £10k lump money and your initial £100/month fixed monthly payment, you may be paying an extra £10/month down the mortgage every month. If you stored it individually, you would not be doing this.

Is this correct? Does it make sense? Or is this insignificant because I used round numbers?

I’m not sure if it’s worth it to run it in a spreadsheet. Please feel free to leave a comment.

Check to see if you have a “capital” repayment need and a “interest” repayment requirement. This is a common error that people make. You have a single balance, and money is deducted from and added to it as you make payments (monthly minimum or overpayments), and interest is charged.

It’s actually rather difficult to put into words why it doesn’t operate the way you’re describing. What we’ve been discussing in this piece effectively takes into account the “higher” “extra” payments you are paying.

I can’t think of one off the top of my mind (I have a spreadsheet, but I can’t share it! ), but you need a calculator that shows you what your outstanding mortgage total would be after several fixed terms with varying starting amounts and monthly instalments. If you find something like that, plug the numbers in and you’ll see that even though your monthly repayment is now more effective in chipping away at your balance (because you’re accruing less interest), it’s no more complicated or difficult to calculate than simply comparing rates, as described throughout this post.

That is only true during your fixed term (and it is only in place to prevent you from frequently moving providers, which is why they normally allow hefty overpayments like 10%). When your fix is up, you can move around, borrow less, borrow more, extend the term, and do a variety of other things. Instead of overpaying the mortgage, pay into a savings account

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