Home—Blog—Should you use your savings to pay down your mortgage?
Apr 20, 2011, 11:30
Posted byMerryn Somerset Webb
Comments (26)
When we did the live webchat for viewers after the second episode of Superscrimpers (a Channel 4 series on personal finance which I’m co-presenting) one of the most-often asked questions was about mortgages and savings. If you have both should you use the savings to pay down your mortgage? Or should you hang on to the cash?
The obvious answer is to make sure you have six months’ worth of living money in a good instant access savings account and use the rest to pay down your mortgage as fast as possible. Why? Because it will save you a fortune in cash.
Say you have a mortgage of £150,000 on a rate of 4% with 15 years left to run and £20,000 in extra cash. If you keep the mortgage at £150,000 and keep making your monthly payments (which will be about £1,110) your total interest bill for the 15 years will come to £49,715. But pay it down now to £130,000 and that comes down to £43,000.
So you’ll save £6,700 – and even more if you keep your monthly payments at £1,110 rather than dropping them to reflect the falling debt. Do that and you will knock two years off your mortgage term and save another £6,000 in interest along the way. So a total of not far off £13,000 saved in interest payments. You can calculate all these numbers with reference to your own mortgage here.
Obviously if you’d kept all the money in a savings account this would have been offset by the interest you would have received on it. But odds are this wouldn’t have been as high as the interest rate on your mortgage. You would also have had to pay tax on it.
So clearly in a rational world, paying down your mortgage is the right thing to do. But we aren’t all entirely rational about money: many of us are loath to lose control of our cash by putting it into our mortgage. We’d rather keep it where we can get at it – regardless of the long term costs.
However all is not lost. For these people there is the offset mortgage. These sound complicated. But they really aren’t. All you do is hold your mortgage and your savings in the same account. That way the money in your savings account is ‘offset’ against your mortgage. This means that you won’t earn any interest on your savings, (and you won't be paying any tax), but you won’t be charged any interest on the same amount of your mortgage either.
This can save you a fortune over the full term of a mortgage. An example from Scottish Widows. Say you have a 25-year £130,000 mortgage with a monthly payment of £824.44 and £15,000 in savings. If you offset the £15,000 you will cut three years and 11 months off your mortgage term and save yourself £38,763 in interest. And best of all you will retain full access to your cash: if you need the money you can just withdraw it.
It used to be that offset mortgages came with higher interest rates than ordinary mortgages. This is no longer really the case: according to Moneynet, the rates are now on average only 0.36% higher than ordinary rates and some lenders charge only 0.1% or so more. That makes the offset mortgage a very attractive option indeed. Think of it as the best of both worlds.
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(20 April 2011, 01:18PM) Complain about this comment
I agree, paying down the mortgage seems to get overlooked compared to saving and investing. To match an overpayment on a 4% mortgage you need to receive 5% return (at 20% tax) or 6.66% (at 40%) and there is zero investment risk!
(20 April 2011, 01:59PM) Complain about this comment
Another vote here for offset mortgages. It has the same financial impact as paying off your mortgage...BUT...if for some reason you suddenly need access to the money you don't have to sell your house or re-mortgage to get at it. Also, for example say over 2 years you intended to accumulate £50,000 in savings and pay that off your mortgage when your current deal expired, you'd only get the interest reduction benefit after 2 years when you remortgaged. But with an offset evey day that you are increasing your savings you are immediately reducing your interest payments from day 1.
(20 April 2011, 02:39PM) Complain about this comment
I am working overseas so my UK property is rented out. My savings are higher than the outstanding mortgage. My accountant has suggested that there is not a clear cut case for paying off the mortgage as I would pay extra tax on the increased lettings profit due to mortgage interest no longer being available as an allowable expense for tax purposes. It really depends on how much interest I can earn by investing the money I would have used to pay off the mortgage. I am a novice investor so I would appreciate any feedback as to whether or not this makes sense.
(21 April 2011, 03:21AM) Complain about this comment
I agree pay down the mortgage, but at the same time a portion should also be invested. The investments will take time to grow, the earlier a person starts investing the better.
(21 April 2011, 06:40AM) Complain about this comment
In a low interest rate and high inflation environment it makes no sense whatsoever to pay off your mortgage. You are far better of hedging inflation and future rate rises with the cash you save and lock in a low interest fixed rate mortgage.
(21 April 2011, 09:53AM) Complain about this comment
Expert 007, have you looked at the mortgage rate tables lately? 5 year fixed are at 5% +. Please explain why it's better to borrow at fixed rate of 5% and earn 2-3% before tax ..... 2-2.5% after 20% tax on cash? How on earth does that act as an inflation hedge. You just end up loosing thousands of pounds a year on an average mortgage. If you are proposing that you invest the money, again tell me how you propose to earn 6.25% ( for a lower rate tax payer ) or 8.3% ( for a higher rate tax payer ) just to break even with the interest saved by paying off the mortgage, with no risk?You may be an expert in something, but I very much doubt it has anything to do with finance/money.....at least I very much hope not.
(21 April 2011, 11:55AM) Complain about this comment
Do readers of this magazine really need such an obvious article?
(21 April 2011, 12:29PM) Complain about this comment
Well this assumes that house prices don't always go up as the British public believes and the BofE and all the 2-home-MPs are doing everything they can to perpetuate. The received wisdom has always been to be as leveraged as you can. Got some equity? Quick, either spend it on a BMW with MEW or leverage up again with a BTL aquisition or by moving to something bigger than you need.
(21 April 2011, 01:18PM) Complain about this comment
@ John, BahrainYour account sounds right. A mortgage on a property that you are renting out is a different matter because the tax benefits work in the other direction. That said, there is no point in reducing your tax bill if you are just handing the money to your mortgage company. You will have to 'do the sums' for each option and factor in the possible changes in interest rates over the next few years and the alternative investments that are available.
(22 April 2011, 08:07AM) Complain about this comment
Alex, This can be a bit tricky to understand but try and think about it like this. In an environment where inflation is running high the real value of the mortgage principal erodes at the prevailing inflation rate. Hence the value of your mortgage will decrease. If inflation is higher than the fixed rate interest you are paying you gain. But you also need to consider the devaluation of any cash savings position you have so even if you are earning 6% interest this (in real terms) only 1% if inflation is running at 5%. So you need to hedge this by buying anything that moves inverse to inflation for example gold futures. Furthermore, there is obviously a risk that rates will rise to combat monetary devaluation so you should hedge this also by going short in short sterling futures with a tenor that matches the time your fixed rate mortgage rolls off. Does that help at all?
(22 April 2011, 01:38PM) Complain about this comment
@ Expert 007Can I ask, have you put your suggestions in to practice with your own money?Also, do gold futures always move inversely with respect to inflation? We have just seen a period of low inflation and even deflation but the gold price has rocketed.
(24 April 2011, 01:14PM) Complain about this comment
A no brainer here, pay the mortgage off. The past 3 years have offered an overpayment window in a low interest rate environment to do so.Mervyn King and the politicians all have several houses BTL's etc, they are overpaying their mortgages at the moment. Rates are going to rise very slowly, mortgages are going to become more unaffordabel. Wages are being squeezed by inflation.The problem is you will reduce your debt but you will not see your cash again because it will be lost by a drop in property prices - real or nominal or indeed collapse if markets turn and rates are forced up (eg debt restructure in europe, hyperinflation)If you are a mortgage holder with a large debt, either way its going to take your money!!!!!
(24 April 2011, 01:22PM) Complain about this comment
debt is the enemy here, the politicans and Merve ,the rate swerve/behind the curve' King are using all their ammo to protect the man on the street who was sold a lie and encouraged into a ponzi scheme. accept you losses, reduce your debt and move on with your life. debt is not wealth.
(24 April 2011, 03:17PM) Complain about this comment
Economies, that's very funny, assume it was meant to be..But the simple fact is - debt is your friend here borrow as much as possible.
(24 April 2011, 05:56PM) Complain about this comment
Yes thanks expert 007,Lucky for me i just managed to make a cracking invetment today, kirsty allsop would be very proud of my wise financial move......My mortgage broker was able to source a £200k interest only BTL mortgage at 6% for me , got an absolute bargain of a 2 bed flat, was on at 400k at peak of the market, estate agent told me seller was desperate to sell and would basically give it away, after tense negoiation i got it for £310k put in £110k of my life savings and borrowed some on credit card to pay stamp duty. just needs a bit of a paint job, new boiler and carpets and its ready to go. Just sitting back now cant wait to retire at 50 and live a life of largesse and excess , first stop the Bentley show room for me.ps phil spencer said he is kicking himself he missed out on this opertunity to set himself up for life, well you have to be out there , the deals are there to be had by those who have the drive and ambition such as i.
(24 April 2011, 06:04PM) Complain about this comment
ps, we live on an island you know, population is growing and God is not making any more land £££££££££££££££££'s guaranteed
(24 April 2011, 06:10PM) Complain about this comment
ps i did watch an episode of location x3 .......on it a poor punter was persuaded by phil to buy a 2 bed rabbit hutch as an investment, even before the end of the programme it was valued at 30k less than he paid for it! (unusual they actually broadcast this fact) to quote phils closing comment " property is ALWAYS a GREAT investment"makes you wonder thats all
(26 April 2011, 02:22PM) Complain about this comment
As Expert 007 says we all have a choice.Reduce a future cheaper debt with today's expensive money. or Invest the proposed over payment in alternative asset classes and let earnings inflation devalue your mortgage debt. I chose the latter. It worked. It brought new meaning to financial independence and greater wealth and lifestyle benefits.
(26 April 2011, 02:25PM) Complain about this comment
(26 April 2011, 02:30PM) Complain about this comment
Pointless article. There is not a single person on this planet who has such a simple choice. There are those with other kinds of debt, a pension to consider, tax implications, no savings, no income, leverage for business expansion etc etc.Most "rational" people spread their risk: pension, property, savings. A banal answer to a banal post. A far more interesting post from an economist would be the trade off between the options. For instance, my mortgage is 0.17% above the BOE. Why would I clear my mortgage at such low rates, probably for years, when I make double digit returns on commodities, most likely for decades? Try again.
(26 April 2011, 04:47PM) Complain about this comment
To be fair, Merryn is weighing up savings accounts vs paying down the mortgage. For some people (like me) on a moderate income with a young family and a mortgage fixed at 5.5%, it is a fairly simple choice. But I agree that if you are in a position to take on more risk and make higher returns, then paying off the mortgage doesn't make so much sense. Particularly if your mortgage rate is very low.
(27 April 2011, 02:28PM) Complain about this comment
Yes. Pay down debt. All debt. Sleep well. Be happy.
(27 April 2011, 03:38PM) Complain about this comment
Everyone prefers a diffrent cup of coffee or tea, right? I agree with DC88 and ricardo. For novice investors there's one strategy and for an expert traders there's another.If one can truley assess the value of any asset class rather than its price and compare it whether its undervalued or overvalued in historical terms then fortunes would be made. Wealth is not lost it's transferred.But taxes and inflation are the real killers to our standard of living (especially inflation that invisibly confiscates our wealth).Also, please remember that shares are just that, shares in a company that processes the goods/commodities/services etc.. They are all subject to share market crashes and money crisis whereas physical precious metals are not...
(28 April 2011, 04:03PM) Complain about this comment
All these scenarios depend on what your interest rate is, whether you're paying interest only or repayment, what interest you're getting on your savings and what the inflation rate is. Dependent on what these 4 variable, it can be both worth while paying off your mortgage or not paying off your mortgage. To argue back and forth is pointless. To understand how these 4 things interact is key especially inflation and how it can both hurt you (erodes cash under the mattress), and be your friend (reduces your mortgage).
(30 April 2011, 10:16PM) Complain about this comment
Expert 007 - Great stuff. I've been thinking about this a lot and I agree with most of what you've said. I was confused with your last comment though, when you talk about hedging against the risk of rising interest rates to combat monetary devaluation. "you should hedge this also by going short in short sterling futures with a tenor that matches the time your fixed rate mortgage rolls off." If you're locking in at a low fixed-rate, why do you care in this scenario if interest rates rise (which they of course will)? Thanks in advance.
(02 May 2011, 01:50PM) Complain about this comment
Investing fan - I agree you don't care through the period of your fixed rate but what i'm saying is that once the fixed rate ends you are exposed to potential higher fixed rates for the next period. Or if you go onto a tracker mortgage you are sensitive to increases in the base rate throughout the term of the mortgage. These can both be hedged so that you make money on the futures that offset any potential increases in mortgage payments. See my point?
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