Which? has analyzed whether it’s beneficial to make extra payments on your mortgage or if utilizing your extra funds elsewhere could be more advantageous. By making overpayments, individuals can potentially save significant amounts on interest and shorten the mortgage duration, but this strategy may not suit everyone.
According to Which?, if the interest rate on your mortgage is higher than your savings account rate, focusing on overpaying the mortgage may be a more financially sound decision. They emphasize that having a savings account with an interest rate equivalent to your mortgage would yield similar returns.
Investing is another option to consider with spare income, but it involves risks. IG’s analysis reveals that, historically, UK stock market investors have seen approximately seven times the real return of cash savers after inflation since 1999. However, investments come with the risk of potential losses, as returns are not guaranteed.
For instance, Which? presents a scenario of someone with a £200,000 mortgage, a 30-year term, and a 5% interest rate. Making additional monthly payments of £50 could shorten the term by two years and ten months, saving £20,924 in interest. By increasing the overpayment to £250 a month, the mortgage term could be reduced by ten years and one month, with £70,796 saved in interest.
When considering alternatives to overpayments, Which? calculates that investing £250 monthly with a 7% return could amass a pot worth £113,686 in about 18 years and six months, which could then clear the remaining mortgage balance. This strategy could reduce the mortgage term by 11 years and 6 months, saving £36,128 in interest. On the other hand, saving £250 a month with a 4% interest rate could take nearly 21 years to accumulate enough funds to pay off the mortgage, shortening the term by nine years and three months and saving £24,315 in interest.
It is important to note that mortgage rates, savings rates, and investment returns are subject to change over time, affecting potential term reductions and interest savings. Reena Sewraz, a Which? Money Expert, advises individuals to carefully evaluate their current financial situation, including mortgage terms, risk tolerance, and financial goals, before deciding whether to overpay their mortgage or opt for saving or investment routes. She stresses the importance of having an emergency fund and settling other debts before considering overpayments.