Your mortgage is likely to be the biggest financial commitment you ever make. So, it’s perhaps no surprise that you might want to pay it off as quickly as you can.
A question many clients ask us is: “should I use my savings to pay off my mortgage?” While the simple answer is that it depends on your specific circumstances, there are some pros and cons of using your cash to reduce or even clear your borrowing.
The pros of paying off your mortgage with savings
There are several benefits to using your savings to pay off your mortgage.
The first is a simple question of security, in that repaying your mortgage means you will own your home outright. For many people, the peace of mind that they own their home, and no longer have the risk associated with a loan secured on the property, is almost more important than any financial benefit.
A second good reason to consider repaying your mortgage with savings is a financial one. Put simply:
- If the return you get on your savings isn’t as good as the interest you pay on your mortgage, it makes sense to overpay
In recent years savings rates have hit record lows. According to analysts Moneyfacts, the best easy-access savings returns in December 2020 only pay around 0.6% to 0.75%. This is likely to be lower than the interest you are paying on your mortgage borrowing.
- Paying interest on a £10,000 mortgage at 2.5% costs £250 a year
- Earning interest on £10,000 savings at 0.75% makes £75 a year
- In this simplified example you’d be £175 a year better off by paying £10,000 off your mortgage than by saving it
It’s worth mentioning here that it may be possible for you to get a higher rate of return on your money than it costs you to borrow.
As we have previously seen, the long-term returns from investing in equities can be greater than cash savings. According to the MSCI World Index, between 31 December 1987 and 31 December 2019, the annualised return of global equities was 7.72% – significantly in excess of the interest you’d likely be charged on a mortgage.
In this instance, you may be able to benefit from low borrowing rates while generating a return on your savings. However, you need to remember that the value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
A final benefit of using savings to repay your mortgage is that it can help you to pay off your mortgage more quickly. Paying lump sums off your mortgage and maintaining your monthly repayment at the same level can take years off your mortgage term and help you to reduce the overall amount of interest you pay.
What you should consider before using savings to pay off your mortgage
While there are many reasons to consider using your savings to pay off your mortgage, there are some factors to bear in mind.
The first is that it might be unwise to commit your savings if you don’t have other savings to fall back on in an emergency, or you have other high interest debts.
For example, many credit cards and store cards charge interest rates of 15% to 20% or more. If you have an outstanding balance on credit, you’re likely to be better off clearing these debts than you are paying off your mortgage at perhaps 2-3%.
You should also make sure that you have an emergency fund in place. Ideally, this should be an easy-access account that contains three to six months’ after-tax pay. Making sure you have a rainy-day fund in place to help you with an unexpected bill or period of unemployment is a key part of financial planning.
If you have decided to use your savings to repay your mortgage, the next factor to consider is how much your lender will allow you to repay without levying an early repayment charge.
If you are benefiting from a fixed, tracker or variable rate deal with your lender, you will typically pay an early repayment charge if you repay some or all of the mortgage within the term of your deal.
However, most lenders allow you to pay 10% of your mortgage balance as an overpayment each year. Check with your lender exactly how much you can pay without incurring a charge. If you are on your lender’s Standard Variable Rate (SVR) then you are likely to be able to repay any amount you like.
An offset mortgage could combine your mortgage and savings
If you want to ensure your savings are working hard for you, but you don’t want to commit them to paying off your mortgage, an offset mortgage may be a useful option.
Here, a lender links your mortgage to one or more savings accounts. If there is money in the account(s), it effectively reduces your mortgage balance, meaning that if you maintain your mortgage repayments at the same level you will typically pay back your mortgage quicker and pay less interest.
For example, if you have a mortgage balance of £200,000 and offset £20,000 in savings, your lender will only charge interest on £180,000.
It’s worth speaking to a mortgage expert to establish whether an offset mortgage might be right for you.
Get in touch
If you are considering how to make the best use of your savings, we can help. Please get in touch by email at email@example.com or call 01454 416 653.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.