Should I Pay Off My Mortgage or Save?
If you are in a position where you have money saved and an outstanding mortgage liability, you may be wondering if it is best to pay off your mortgage or continue saving. Both paying off your mortgage and saving have advantages and there is no definitive answer. However, in many cases, especially in a high interest rate environment, you should aim to pay off your mortgage with your savings.
This article explains the benefits and pitfalls of paying your mortgage from your savings and will help you get an understanding of when you should pay off your mortgage.
Let’s explore savings and paying off your mortgage further.
How Can You Pay Off Your Mortgage Early?
All lenders in the UK allow you to repay your mortgage early, although many lenders enforce early repayment charges to dissuade this.
To make an overpayment or pay off your mortgage, you should contact your lender and ask if there is any early repayment charge. You can also check your mortgage paperwork as the early repayment charge will be outlined clearly in your documentation.
What is an Early Repayment Charge?
When a lender offers a mortgage product they apply an interest rate to the amount you borrow. This interest rate is the lender’s profit. A lender calculates how much profit they will make from each mortgage product they offer.
The interest is a monthly payment and the lender’s profit is split over the number of months you hold the product. If you decide to repay a mortgage early or make an overpayment you are reducing the amount of profit the lender can make from the mortgage.
To dissuade customers from making overpayments, many lenders operate early repayment charges which are financial penalties when you make overpayments or repay your mortgage early.
How Much is an Early Repayment Charge?
The amount a lender charges differs from one lender to the next. Some lenders have lower early repayment charges while others can have penalties that are more than £10,000. Early Repayment Charges are normally applied as a percentage of the loan sum.
Do Early Repayment Charges Always Apply?
In most cases, an early repayment charge will only be levied within the product term of your mortgage. For example, if you take a 5-year fixed rate, the early repayment charge will be in force for 5 years. With many mortgage products, the ERC percentage payable falls each year until the product term expires.
Beyond your deal term, lenders expect you to remortgage and don’t penalise you with early repayment charges. However, you may still find administration fees are charged by a lender if you pay off a mortgage product.
These administration fees are typically much less than an early repayment charge, such as between £100 and £300, and not all lenders apply them.
Benefits of Paying Off a Mortgage Early
Even if you have an early repayment charge, there are circumstances where paying off a mortgage is still beneficial.
For example, if you have a mortgage product with 4 years of your product term remaining and your interest is £150 each month your total interest payment would be £7,200. That same product may only have an early repayment charge of £2000, making it beneficial to pay your mortgage early.
Some lenders allow you to make overpayments up to a certain percentage of the outstanding balance without incurring any early repayment charge. These are extremely beneficial if you have this type of mortgage as the overpayments will reduce the amount of capital and interest owed on the mortgage. Most lenders allow overpayments up to 10% of the balance per annum.
Finally, if you pay off your mortgage in full, you have no ongoing monthly cost. If your mortgage payment is £900 per month, you have reduced your monthly expenditure by £900.
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Does Your Mortgage Type Make a Difference
The type of mortgage you have will not play a big role in your decision to repay the mortgage outside of the above-mentioned early repayment charges.
Instead, the interest rate payable is likely to be the most significant factor in deciding whether to use your savings to pay off your mortgage.
Should I Use My Savings to Pay Off My Mortgage
To calculate whether you are best to continue saving or pay off your mortgage you need to do a simple equation.
Is the interest rate on your mortgage higher than the amount you are making on your savings?
If the answer is yes, you are best paying off the mortgage from savings providing you have factored in any early repayment charges.
If no, you should continue saving. It is rarely the case that your savings make a higher amount of interest than your mortgage charges. However, investment accounts and portfolios can have higher return on investment.
The reason why you should pay off your mortgage (if it has a higher interest rate than your savings accounts) is because you will be financially better off in the long-run.
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Is it Better to Pay Off My Mortgage or Save For Retirement?
Savings can be used for many situations and retirement is always a big consideration.
The rule above about interest rates applies when answering whether it is better to pay off a mortgage or save for retirement. The outcome remains the same.
In the short term you may feel daunted by your retirement pot being eaten away by paying off your mortgage, but in the long term you will have no ongoing monthly mortgage payments at the higher interest rate and will be in a better position to save for retirement.
Speak to a Specialist
Of course, general financial ‘good practice’ will only be applicable on a generalised basis. You should always consult with a financial adviser or a mortgage broker when deciding if paying off your mortgage is right for your situation.
A mortgage broker can review your current financial situation and your existing mortgage product to make a detailed recommendation on how to proceed. Ultimately, the decision will always be in your hands and you will need to decide if you are comfortable using your savings to pay off your mortgage.
A worry that many people have about using up their savings is that they might not have enough for an emergency. A mortgage broker can highlight any shortfalls you have and recommend protection insurance products to cover them.
Boon Brokers is a Whole of Market Mortgage, Insurance and Equity Release Brokerage, providing free, no obligation mortgage advice. Contact us to book your mortgage advice consultation today.