Savings or mortgage overpayments

Strawberry_virgin

Two years ago, I took out a capital repayment mortgage of £95,000 over 30 years term with Northern Rock tied up for 15 years on fixed interest rate at 4.89%. I am considering making overpayment of £250 each month. Would I be better off opening a high interest savings account or ISA instead now that the interest rates have gone up? All suggestions will be much appreciated.

kedj

Yes, since rates have gone up - you would be better off paying into a cash isa than overpaying the mortgage.
If you are basic rate tax payer, then you should also find accounts paying a return over 4.89% after tax too. With 15 years fixed, you may also want to look into making some regular investments rather than just savings accounts.

Primrose

There are a lot of Cash ISAs around offering more than the 4.89% interest you are paying on your mortgage so opting for an ISA with your £250 per month would seem a sensible option. However, do you have an emergency savings account? If not, you might be wise to build up one first containing a minimum of 3 months living expenses, just in case some sudden hiccup in case you unable to work through sickness or redundancy. Also if you will be approaching retirement by the time your mortgage is paid off and think you might want to have the option of retiring early (or covering your options in case you're made redundant at a late age), having your mortgage paid off early might give you great peace of mind. If you're unsure which route to take, why not split your £250 between both options?

Strawberry_virgin

Thanks kedj and primrose, some good points there especially with having emergency savings account. I never really considered need for one since I work for the local government and in the profession currently in great demand but guess you can never relay on being healthy forever.
I am not sure if investments are really for me especially if there are any risks involved.
I’ve read somewhere that the rate of return on savings can’t be directly offset against mortgage interest but not sure how to explain this.
My aim is to pay off my mortgage by end of the fixed term i.e another 13 years and it looks that making regular overpayments of £250 each month would just about do it.
I guess the best way is to call Northern Rock and check what would be my outstanding balance after 13 years and this will be accurate since I am on the fixed rate. I can then look around for saving accounts that will give me projected net return greater than my closing balance based on the same deposits (or at least I think it’s as simple as this).
I am also looking to start the Local Government Pension Scheme in January 08 but not sure how this scheme operates, so more on this later.

kedj

Yes the principle is that simple. If you save £250 a month into a cash isa which continues to pay say 6%, then at the end of your 13 years you will have more money sitting in your account than the amount which would have been reduced from your mortgage. If in the future, interest rates keep rising then you could earn some good extra interest by doing this.

95k over 30 years should give you a repayment £508.55. Whereas a 15 year term would need £757, so a £250 overpayment should clear you mortgage in 15years.

If you dont make any overpayments, after 15 years you would have an outstanding balance of £63817. But if you paid that £250 per month into a cash isa, which consistently earned 6% for 15years - you should be looking at around £72k in your account.

You would also need to check what overpayments you are allowed to make, without penalty.

Strawberry_virgin

Thanks for that kedj, Northern Rock does allow me to make regular overpayments without penalties as long I don’t pay it off in full before end of the 15 years term. It does appear at the moment the trade off is in favour of savings with higher interest rates and I wouldn’t rule out another increase by end of the year. The only thing I’ve noticed is that you are calculating savings return over 15 years as opposed to 13. I am already two years into my 15 year term during which I was only making regular payments and paid off about 2k of my mortgage. At 6% return over 13 years, I would have about 58k which would leave me 6k short, so I would need to save £265 a month to be on target. The 6.68% BMW ISA fixed for 13 months looks very good at the moment.
I guess it would be interesting to set myself a challenge to make up the 6k shortfall without exceeding £250 deposit every month by using tips from moneysavingexpert forums.

kedj

I did both the savings and the mortgage calc over 15years - so after 13years your surplus cash would be a little less, but it would still be a surplus not a shortfall. So long as the interest rate on you isa exceeds your mortgage, you will have a surplus amount.

Strawberry_virgin

Just realised my question has been answered before.
http://www.moneysavingexpert.com/mortgages/mortgages-vs-savings

You are right kedj, it doesn’t matter at what point in time you compare the two, as long the mortgage rate like in my case is below the rate of return you can get from ISA or savings it’s the way to go. I got confused when using the mortgage calculator. It was showing my mortgage would be paid off by year 15 if I overpaid £250 each month but of course, this was on the basis you start overpayments from day one. My savings return was showing less because I was calculating on 13 years. The above article is good as it highlights how to maximise your overpayments if repaying mortgage instead of savings i.e my interest is calculated at the beginning of each month (monthly). I would be even better off to put my £250 each month into instant access savings or ISA and only pay in few days before the interest is calculated. It may not be much but I bet it adds up over 15 years. In any case, £250 a month would come exactly to £3,000 a year allowed for ISA. Another good feature of my mortgage is that I can borrow back my overpayments eliminating the need for emergency savings.

kedj

At the moment, you can be quite happy about locking in to a rate below 5%. Anything you earn above that is like a bit of free money! Good luck with it.