With the current very low interest rates on savings, whereby many savings accounts are only earning a measly 0.01% of interest per year, some people have been thinking about using any spare cash they have saved during the pandemic lockdown, to put towards paying off the mortgage debt.
So, in today’s blog we will consider if the best option is to either, save money or pay off a mortgage.
Should I save money or pay off the mortgage?
If you are one of the lucky ones and the COVID pandemic has left you in a comfortable position financially, and you are relatively cash rich, then you may have thought to yourself, should I save the money or pay off the mortgage?
With interest rates at all-time lows at the moment, the question of whether to save money or pay off the mortgage is indeed a relevant one.
All things being equal, which of course they are not in the real world, then the question can be answered using very simple mathematics.
If your mortgage interest rate is higher than the interest rate on your cash savings, which I could almost guarantee is the case, then it is indeed a sensible idea to consider paying off your mortgage debt with any spare cash.
For example, a real-life situation could be a fixed mortgage deal of 2.5% versus an instant access cash savings account of 0.01%, which is effectively zero!
This means you are paying considerably more interest on your mortgage debt than you are receiving on your cash savings income, and so the answer to the question should you save money or pay off the mortgage is a resounding yes.
However, it isn't quite as simple as that. When considering whether to save money or pay off a mortgage, you must consider other factors.
For example, no matter how much cash you have stored, it is usually a good idea to keep at least three months’ worth of expenditure and preferably six months in an easy access account as a rainy-day fund for any unforeseen emergencies, such as a car breakdown, boiler breakdown, leaky roof, washing machine breakdown, and so on.
You should also consider any demand on cash in the near future and take that into account as well.
What are the advantages of paying off a mortgage early?
There are two main advantages of paying off your mortgage early, and a third more psychological advantage.
Firstly, each time you pay off a lump sum or an additional monthly sum of your mortgage payments, means that the interest charged each month is slightly less, or of course significantly less depending on how much you pay off.
This ultimately means that you will be paying far less interest both on a monthly basis, and on an overall basis spread over a number of years or even decades.
When doing the calculations, it is quite possible to save thousands upon thousands of pounds just by overpaying the mortgage.
Secondly, when you overpay your mortgage, the length of the mortgage also reduces, so as well as saving many thousands of pounds over the long term, you can also reduce the length of your mortgage period from either 25 years or 30 years which are now quite commonplace, by many many years.
Sometimes even chopping 5 to 10 years off your mortgage is possible if you are aggressively paying down your mortgage or contributing significant lump sums each year, for example from a bonus from your work.
The third psychological advantage of paying off your mortgage early is a sense of personal achievement, as clearing your mortgage debt is one of life’s really big milestones.
Having the mill stone of a huge mortgage debt hanging over your head for years and years can really boost your enthusiasm and appreciation for life, and the ecstatic feeling of finally clearing your mortgage should not be underestimated.
Are there any disadvantages of paying off your mortgage early?
Whilst there are no serious or significant disadvantages to paying off your mortgage early, and so long as your mortgage interest rate is higher than the interest rate you can achieve on your secure savings, then paying off your mortgage instead of saving is usually the right thing to do.
However, just a word of warning, you should check your mortgage contract terms and conditions with your provider, as some fixed term contracts or discount contracts or trackers may have certain clauses in them that restrict the amount that you can overpay.
Some allow you to overpay your mortgage each and every month, whereas others only allow you to overpay once a year.
There can also be a restriction on the amount you can overpay your mortgage by each year, for example a maximum of 10% overpayment is quite typical if you have a fixed contract or a fixed term tracker rate.
Most SVR mortgages or standard variable rate mortgages allow you to overpay as much as you want as often as you want, but do be aware that SVR mortgages are usually more expensive than fixed term contracts.
You would also be at a disadvantage if you used all of your spare cash to pay down your mortgage debt, as paying down your mortgage debt is irreversible, and you can't get your money back.
Therefore, if you did have a sudden emergency for example were made redundant or were fired from work, then you could be left short of cash if you had overstretched yourself by paying off such a large chunk of your mortgage.
Should I pay off my mortgage early with extra monthly payments or as a lump sum payment each year?
This very much depends on the exact terms of your personal mortgage contract as well as how much you can realistically overpay. Many mortgage lenders will now allow you to overpay your mortgage each month by setting up a regular standing order.
You can also overpay by a lump sum either once a year or several times throughout the year, whilst always mindful of not paying too much back if it breaches the mortgage lenders maximum payback rule of say circa 10%.
If you can, a combination of a small regular overpayment each month, coupled with more significant overpayments as and when the opportunity arises, for example if you receive a bonus from work, can work to maximise the effect of overpaying your mortgage and reducing debt payments and mortgage duration.
Why do some people keep a small mortgage just ticking over?
Many years ago, it was quite a common practice and often recommended that a mortgage owner just kept a small amount of debt on their mortgage balance so that their provider had to keep the title deeds for their house in a secure location, thus saving the homeowner several 100 pounds per year.
Nowadays, it is far more common for homeowner’s title deeds to be stored digitally and so there is realistically no need to keep a small mortgage ticking over, and you may as well pay the whole thing off and close the mortgage down.
The only caveat to closing the mortgage down fully is if you think you may need to borrow more at some point in the near future, then applying for a top up or re mortgage with an existing mortgage already open can on occasions prove easier than starting the whole mortgage application process again.