Michael White of online advisers Email Mortgages explains the benefits of paying more than you are obliged to for your mortgage every month.
In these 'money saving' times, when advice about financial matters is more sought after than ever before and everyone considers all manner of ways to save cash on every expense, it is surprising how few people concentrate on the biggest financial burden they are ever likely to have: their mortgage.
The monthly mortgage payment is often viewed as a 'given'; it can't be changed so people continue to let it run as always and in that sense, borrowers are accepting that they'll probably have the debt for at least 25 years and there's nothing they can do about it. Of course, this is very far from the truth; one only has to consider the simple act of overpaying the mortgage each month to find a highly suitable way to save large sums over the life of the mortgage.
The benefits to be had from overpaying your mortgage can be so significant that it is often surprising how few borrowers actually do it. With the mortgage being the most long-term financial responsibility an individual will have, anything that cuts the number of years you will have your mortgage for and also decreases the overall amount you will have to pay through saving on the interest payable is obviously a good thing.
Overpaying also increases the amount of equity you have in the property, thus allowing you to access far more competitive mortgage deals when you come to look for new mortgage finance.
The reality is that most borrowers do not overpay for the simple fact that their monthly mortgage payment is probably at the top end of what they can afford and they either do not have the spare cash to overpay, or they are using any spare money available for savings, to pay other debts or fund other purchases.
Of course overpaying where possible is a good idea because you will get the benefits from it as outlined above. However, we should not forget that (with most lenders) once that spare cash is paid into the mortgage, it is gone and cannot be used for anything else. This is why many borrowers prefer to keep their spare cash 'liquid' in savings accounts where they can access it for whatever they wish.
In this latter scenario we should acknowledge the spare cash is very rarely used for overpaying the mortgage, instead most opt for other uses for it.
The cut in Bank Base Rate to its record level of 0.5% has provided a significant boost for those who have perhaps wanted to overpay but have not felt able to. As a mortgage adviser we advise any borrower who has seen their rate - and therefore their monthly mortgage payment - drop to think about continuing their payments at a, shall we say, more 'standard level'. This could be continuing to pay the original monthly amount before the drop - in many cases this will allow them to overpay by many hundreds of pounds each month.
We suggest this because the current situation will not last forever; rates will eventually rise to more 'normal' levels and at this point it is important the borrower does not suffer payment shock caused by this increase. In effect, we suggest that borrowers in this particular case do not base their living standards on this new lower monthly mortgage payment because sure as eggs are eggs, these payments will increase in the relatively near future.
Again, if you are in this situation and you're not willing to overpay then use the extra money to pay off other debts, save it in an ISA, fund other investments, etc.
We should also remember that most lenders will only allow a certain amount of overpayment every year; typically 10% of the overall mortgage amount. The longer they have you on their books, the more profitable you are to them. This is why paying off the mortgage during the period of any special deal is often subject to Early Repayment Charges (ERCs). Don't forget that if you have a flexible mortgage the 10% 'rule' will probably not apply, although there may still be an ERC.
Interestingly, many borrowers who opt for flexible mortgages don't use the facilities that come with them, for example, the ability to make overpayments or take payment holidays. It is not so much the case nowadays, however flexible products often come with a higher rate and therefore if you are not going to use the flexible facilities it is pointless you have the mortgage.
As stated previously, most mortgages will allow up to 10% overpayment a year anyway so it may well be worth remortgaging away from a flexible product if you are only intended to overpay by this much.
Finally, for those who want the benefits of overpayment without technically overpaying, there is always the option of an offset mortgage. Here, instead of putting your savings into a separate account or ISA, you choose to put them in an offset pot alongside the mortgage. Instead of earning interest on the savings you offset the interest you would have earned against your mortgage, effectively overpaying.
With normal savings rates being particularly low, many borrowers with significant savings would benefit from offsetting as they would earn the equivalent of the mortgage rate on their savings. This method of overpaying also allows the borrower to keep their savings 'liquid' as they can always access the money from the offset pot at any time.
It is also worth bearing in mind that any interest you earn on your savings is taxable at your highest rate of income tax, which might be 20%, 40% or, as of April 50% for the highest earners. If you use your savings to overpay your mortgage instead, not only are you effectively earning interest on them at the mortgage rate, but because they no longer technically exist as 'savings' you do not pay any tax.
Michael White is chief executive of online mortgage advisers, Email Mortgages (www.emailmortgages.com)