Pay Mortgage or Save Money? Should you use your savings to pay off your mortgage

By Lorrie Kelly Staff Writer Monday, 19 May 2008

Pay Mortgage or Save? Questions to ask yourself first: Do you have a fixed rate or flexible rate mortgage? Does your flexible mortgage place restrictions on how much you can overpay? Are there penalties for over or underpayment per month? Are the penalties or fees going to exceed any gains you'll make by overpaying? Related Personal Finance Features and News See our other recent related news stories: How to get the best interest on your savings There has never been a better time to save, as banks try their hardest to lure new customers in the shadow of the credit crunch. Sarah Wray walks you through the best ways to save your money in her easy-to-read guide to savings. Mattress safer than bank for savings, say nervous Britons Despite the almost unbelievable savings interest rates available at the moment, consumer confidence in British banks is now so low that a record number of people feel the mattress is a safer place for their money than the bank. Mortgage approvals hit record low as negative equity fears loom The fear of nineties-style negative equity chaos is looming large, reports David Sewell Stevens as mortgage approvals hit a record low alongside ever decreasing house prices.

IT is generally accepted that paying off your existing debts before saving your money is the best way to stretch every pound but does this rule make financial sense when applied to your mortgage?

Paying as little as £100 extra per month on a £100,000 mortgage could reduce your total repayment by more than £27,000.

That's the equivalent of knocking off 6 years from a 25 year mortgage contract!

Though this may seem a very tempting prospect, but be sure to read the fine print before you start increasing your monthly payments.

What's good for the credit card...

Credit cards can charge 16% or more in interest, making it easy to understand why paying off these debts would be more beneficial than placing your money into an average savings account that only earns 6%.

And experts agree that if you have credit card debts and a savings account you are overspending and should rethink your financial strategy. As a rule of thumb, credit card debts should always be paid off with your existing savings.

But the same does not hold true for mortgages.

Penalties on fixed rate mortgages

Most mortgages are set at very low rates and often charge penalties for overpayments or early pay-off making the option of paying them down less than ideal.

For example, if you are on a special fixed or discounted mortgage rate deal, there may be an early redemption penalty.

This is a fee that is imposed if your mortgage is paid back earlier than previously agreed.

What’s worse is these penalties can carry over for several years after the deal is over, making overpays an unwise choice.

Flexible mortgages allow overpayments

However, a flexible or 'offset' mortgage which recalculates your balance daily is a different matter, as these kinds of loans are designed to allow you to pay off their debt faster.

This means any excess mortgage payments you make will yield far more than a regular savings account.

Most flexible rate mortgages usually allow you to overpay or underpay without penalties, and the amount you pay per month can be tailored to how thick or thin your wallet is looking at the time.

When flexible mortgages lose their flex

However, not all flexible mortgages are alike and some may place restrictions on how much you can overpay – termed ‘minimum’ or ‘maximum’ overpay amounts which are normally set per month.

Be careful of hidden fees that your lender may charge for exceeding set maximum limits or not meeting minimum limits under your contract.

These should be leveraged against any gains to more accurately gauge whether being mortgage free is truly the best option.

For example, if your mortgage has a set minimum for overpays and you don’t pay at least this amount you will likely be giving your mortgage lender a free loan for the year.

It would be better to hold your money in an interest earning savings account – some currently offering as high as 7.1% - until you have enough to satisfy their minimum limit.

So, should you do it?

So, before you decide which option is best for you, read through your mortgage contract to gain a better picture of how paying down your mortgage will affect you and spend some time shopping around for the best savings interest rates.

By closely examining both, you will be able to make a choice that places you in a stronger financial position.