When it doesn’t pay to overpay on your mortgage

Jonbvn

http://www.timesonline.co.uk/tol/money/property_and_mortgages/article6689127.ece

Interesting article from the Times, mainly applicable to those on low IR trackers.

davetrousers

This had crossed my mind. My fixed rate has just finished and my mortgage has now dropped to 1.49%. Then you see an advert on TV for a savings account with 6% interest.

TOPAZ_2

This gives some people the perfect opportunity to do a DIY offset - then when the situation switches the other way and they cant get more interest than their mortgage costs - then they can cash in their "DIY Offset Savings" and pay off the mortgage - after first checking the situation with penalty fees.

Topaz

bunking_off

The equation is pretty simple; if the net interest you get on a savings account is greater than the cost of your mortgage, then put the money in there, otherwise overpay.

The caveats are having liquid savings equivalent to a few months' income to tide you over should things go wrong, and to be careful that if you put money in savings and the equation subsequently reverses, you can overpay (as Topaz alludes to, if there's a limit on how much you can overpay per year, may not be able to get the money out of savings into your mortgage without exceeding it).

What I found disturbing in the article was the lack of attention to long versus short-term savings deals. For example there's a 5 yr bond mentioned, at 5.1%. In that time an awful lot can happen to interest rates and I'd be surprised if over that term even the best tracker rates don't go over 3.06% (net return for a 40% taxpayer). So, depending upon the rules for withdrawal, if you go down the savings route you could find yourself sat on a rate that's way below what you're paying on your mortgage, but unable to get at your money to remedy the situation.

Jonbvn

bunking_off wrote: »

What I found disturbing in the article was the lack of attention to long versus short-term savings deals. For example there's a 5 yr bond mentioned, at 5.1%. In that time an awful lot can happen to interest rates and I'd be surprised if over that term even the best tracker rates don't go over 3.06% (net return for a 40% taxpayer). So, depending upon the rules for withdrawal, if you go down the savings route you could find yourself sat on a rate that's way below what you're paying on your mortgage, but unable to get at your money to remedy the situation.

I would agree that liquidity is important. For this reason, we have gone for the Newcastle 5-yr fixed rate at 5%, since it allows you to withdraw funds with 90-days notice. They also offer an ISA with the same basic T&C's.

Jonbvn

davetrousers wrote: »

This had crossed my mind. My fixed rate has just finished and my mortgage has now dropped to 1.49%. Then you see an advert on TV for a savings account with 6% interest.

Do you have details of the 6% account?

Peelerfart

As a further factor, if there is any likelyhood of job loss then it may not be a good idea to have to much in banked. They will ask how much you have in savings
I'm unsure of the numbers but a figure of £16,000 springs to mind .

MrC-117

This is something I think about quite a lot actually. I've ended up with some savings and some overpayments to try to cover everything. My mortgage rate is low and I know I could be slightly better off putting money into savings accounts.

The article doesn't mention if you're allowed unlimited overpayments or not. For example, you save up £20k and then are trying to feed this into a mortgage at £500 a month potentially making you worse off.

A five year fixed bond is only that good if the rates stay low. If they go high then you've got your money stuck at a relatively low rate.

A lot of the good rates on savings have clauses, like if you miss a payment you go to the default rate of 0.1% or you have to open a current account with them to get the savings account, etc. Then you're only on a bonus rate for a year before going back to the normal rates.

Overall it's an interesting article but I wish they'd gone into a bit more depth of the downsides of saving versus overpaying.

Jonbvn

MrC-117 wrote: »

My mortgage rate is low and I know I could be slightly better off putting money into savings accounts.

Given your 0.88% mtg rate detailed in your signature, you would surely be far better off saving then OPing?

MrC-117 wrote: »

The article doesn't mention if you're allowed unlimited overpayments or not. For example, you save up £20k and then are trying to feed this into a mortgage at £500 a month potentially making you worse off.

It does mention ultra-low trackers (like yours), which generally allow penalty free OP's.

MrC-117 wrote: »

A five year fixed bond is only that good if the rates stay low. If they go high then you've got your money stuck at a relatively low rate.

Agreed that this is relevant. It is therefore best to stick to accounts where you can get the money within a reasonable time-frame.

MrC-117 wrote: »

A lot of the good rates on savings have clauses, like if you miss a payment you go to the default rate of 0.1% or you have to open a current account with them to get the savings account, etc. Then you're only on a bonus rate for a year before going back to the normal rates.

We continually chop and change our savings accounts to get the best rates. Doesn't everyone on MSE?

MrC-117

Really I was just moaning a bit about the article not covering some things like what if you're not allowed to make large overpayments (not an issue for me, but it might be for a lot of people).

The sort of savings they were talking about were about £80 a year. OK, it's better in my pocket than the banks, but it's not really a huge amount. If you've put it in your mortgage you won't be tempted to spend it, and you won't have to keep monitoring savings rates quite so much and forget to move them. Plus there's the downsides like Peelerfart pointed out. And I really think they missed the point saying how good the five year bonds are! Just my opinion though

StuartGMC

Interesting debate; from my perspective the issues for me are;
1) As noted, if you are redundant and need means tested benefits you can't get them until you've depleted your savings to £16k (max).
2) In addition to the mortgage and emergency savings, you should include long term investment and of course pension. Your long term investments may well start to exceed the £16k limit but if like presently this represents an actual loss for you, the last thing you want is to be forced to crystalise the losses. For 7-10yr considerations, now is an excellent time to be putting money into funds (or if you have time to DYOR individual equities) which should give much better returns
3) You cannot drop your savings into the mortgage ahead of redundancy so you can claim benefits (deliberate reduction of assets); not applicable if there has been steady overpayment in the meantime
4) Base rates may be back to 5% by late 2012, at which time a 5-yr fix won't look nearly so attractive
5) Lower capital outstanding can reduce the life insurance you need to pay to cover it; not listed in the savings consideration
6) If base rates rise as fast as they fell, can you lock-in fast enough?

Our position is we offset, overpay and invest (Funds ISAs), although I would like to be MF quickly to have that cash to invest more before the markets pick up, inflation increases (forcing up BoE base rate) and hence interest rates also.

Our own household budgeting spreadsheet gives us the equivalent interest rate for offset by accounting for the lost opportunity of interest earned on savings. Makes it easy to see the benefit or otherwise and of course offset to 75% means you only see a change of 1/4 of the interest rate change on the mortgage (roughly).