Savings or (B2L) mortgage overpayments (tax implications)

jonny2510

I'm hoping someone can confirm my way of thinking, or tell me where I'm going wrong!

I'm trying to work out whether it's better to put spare cash (each month) into savings, or use to overpay on my buy to let mortgage. It's the tax that's confusing me!

In terms of flexibility - it's a draw. The savings would need to be easy access. The mortgage has an overpayment reserve meaning anything overpaid can be retrieved within about 2 weeks. There are no penalties for overpaying. Therefore it all comes down to costs:

• Assume a lump sum of £1000
• I'm a basic rate tax payer
• Assume savings rate of 3.1% gross (so 2.48% net)
• Assume a mortgage rate of 4%

Option 1 - Save money:
Savings Interest earned: £31 gross / £24.80 net
Loan Interest paid on same amount (i.e. not put against mortgage): £-40
Tax I would be able to claim back: £8 (= 20% of £40)

Therefore total at the end of the year for this £1000 is:
£24.8 (savings) - £40 (mortgage payment) + £8 (tax refund) = £-7.20 loss

Option 2 - Overpay Mortgage:
Savings interest earned: £0
Loan Interest paid on same amount on mortgage: £0
Money lost due to tax that I can't claim back: £-8

Therefore total at the end of the year for this £1000 is
= £-8.00 loss


From the above, I make savings to be the winning choice. Does anyone disagree. Have I missed something significant?

Also, am I right in assuming that in order to claim tax of £8.00 back against my mortgage interest payments, I'd need to have made at least £40 profit overall for the property?

(Please note the £1000 figure is just an example to keep the illustration simple. In these circumstance ISA and overpaying on current mortgage are not an option either).

CLAPTON

basically
no

your options are very muddled :
the options are

option 1 saving :
means you earn 24.8 interest (ii.e 1000 x 3.1% x 0.8)
so gain is 24.8
no change in the mortgage

option 2 mortgage overpayment

your interest decreases on the mortgage by 1000 x 4% = 40 but net of tax means 40 x .8 so you are better off by 32
no change to savings

so paying the mortgage off gives you a better return

which conforms with the general rule which is to repay debt if the APR of the debt (adjusted for tax) is greater thean the AER (adjusted for tax ) of your savings

jonny2510

Thanks for your response,

though what I don't understand is that (your version) of option 1 doesn't take into account that my loan amount will be £1000 more than it would be in option 2 over the course of the year (due to the money being in savings, and not overpaid). This would lead to paying more loan interest on that extra £1000, and would therefore give the option to offset that against any profits made, reducing the tax liability on my self assessment...

...wouldn't it???

CLAPTON

you have two options

1. you save the money and earn interest

or

2. you use the money to reduce your mortgage and pay less interest

you can't do both

so starting where you are today
then
option 1 you save and make a little interest
no change to your mortgage interest

so you are better off by the amount of interest earned

or
2. you don't save so make no interest
but your interest on the BTL is reduced

so you are better off by the reduction is your out goings (i.e. less interest to pay


the amount of interest earned by savings is less than the reduction in mortgage interest so it would be better to reduce the mortgage (although all rather marginal)

CLAPTON

should have added

in your analysis in option 2 you say you loss £8 because you can't reclaim the tax; however you have misssed out that you pay less interest as the mortgage is reduced; so you mortgage reduces by 40 (a gain to you) but you lose the 8 tax so you are better off by £32 which is more than the option 1 with a gain of 24.80 in savings interest

JRG

You don't say how many years your mortgage has to run, but by paying off £1000 each year you could pay it off early and save several £1000s in interest. If you saved £1000 each year you might accumulate many £1000s, but inflation will reduce its value over time.

If you don't think you'll need the money over the life of the mortgage, then pay off the mortgage, otherwise put it into savings. Alternatively, split it - £500 off the mortgage, £500 into savings. In later years, if you can afford to, you can use some of the accumulated savings to pay off some of the mortgage.