Savings vs mortgage

fizzyq

Hi, I’ve just run the calculator on savings vs mortgage overpayment and it’s suggested I’m marginally better to save the money than over pay and reduce my mortgage by 7 years. 

I’m confused how this can be and probably not understanding properly but I thought it always better to over pay as the present value  of the money in savings will be worth considerably less, but I guess the debt will be too.

it just seems like the wrong think to do for the sake of a lifetime improvement of a couple k? 

amanda1024

You’re right that the present value of the savings and mortgage will both decrease at the same rate (the discount rate, in economist speak). It sounds like you can get a better rate from keeping the money in a savings account than overpaying the mortgage so £ wise you’d be better off saving - plus there’s an extra utility of having the money available in case of any unexpected expenditure.

stuartp2000

There are a few other benefits of paying off the mortage than having savings interest that are not pure financial decisions.

A lot of people always say that the piece of mind from paying off the mortgage is amazing and knowing it is all yours is well worth the lost interest.
I am also myself mindful that savings for a mortgage overpayment at a later date are just savings and as we are all human and events happen then we look at that balance in x years time and decide hmm I wonder if i can do this or that and then the mortgage free year is moved.

It really is personal, obvioulsy a board like this is about the financial and yes if the interst earned is better than the interest saved then do savings and visa versa but to me it is not about a few quid here and there it is about the certainly that the house is mine and no bank can take from me.
I am thus overpaying my 10% from this year and saving the rest in a pot to then settle when the balance is higher than the remaining mortgage.

That is after having funded true expenses and an emergency fund so the pressure to dip into the savings pot is removed as much as I can predict.

junglist_matty

For simplicity, lets consider a mortgage of £100k and (unrealistically, but to keep things simple) there are no monthly mortgage repayments. The interest rate on the mortgage is fixed at 2%, therefore:

- After 1x year, the mortgage debt will grow from £100k to £102k (because of the 2% interest - 2% of 100k is £2k).

Let's say you won £10k of prize money and you decide to overpay the mortgage by £10k. The interest over the next year is calculated as 2% of £90k which comes to £1800... So by overpaying you have saved yourself £200 in interest.

However, if you had saved that money in a 5% saver, you'd have earned £500 in interest, so you'd be £300 worse off by over-paying vs saving.


Simply speaking, you take the interest rate from savings and deduct the interest rate for your mortgage to get the actual interest rate you'll earn; in the case above, 5% saver interest and 2% mortgage means 5% - 2% = 3% saver interest.... The closer those rates, the less you'll earn in savings (or negative if your mortgage is over 5%). If you have loads of savings, a good mortgage rate and a good saver rate it might be worthwhile, otherwise it's probably best just to overpay.

Hoenir

junglist_matty said:

- After 1x year, the mortgage debt will grow from £100k to £102k (because of the 2% interest - 2% of 100k is £2k).

Mortgage interest isn't (normally) charged annually in arrears though. It's calculated on a daily basis and charged monthly. Making overpayments therefore has an immediate (albeit) small impact.  Akin to rolling a snowball. Over time grows larger and larger . Compounding being the key.  

fizzyq

Thanks all so much for taking the time to reply, for me I think it’s the peace of mind of over paying the mortgage that has an additional value but noted it might not make the most financial sense.

I think I will divide and conquer, reduce my intended overpayments in half and put the balance into savings.

Thanks all! 

junglist_matty

Hoenir said:

junglist_matty said:

- After 1x year, the mortgage debt will grow from £100k to £102k (because of the 2% interest - 2% of 100k is £2k).

Mortgage interest isn't (normally) charged annually in arrears though. It's calculated on a daily basis and charged monthly. Making overpayments therefore has an immediate (albeit) small impact.  Akin to rolling a snowball. Over time grows larger and larger . Compounding being the key.  

Sure, I was trying to keep it simple but your point is completely valid and would cause something like an extra £100 in interest charges.