Should I use my savings to pay off my mortgage?

Paying off any debt that accumulates interest is always a sensible option as, more often than not, the interest cost of a debt will be higher than the interest earned on savings. However, there is a lot to consider before you decide whether paying off your mortgage early is the best thing to do with your money:

Is paying mortgage off in full a good idea?

It can be, but you may be charged a fee. You can pay your mortgage off early by making regular overpayments or using one-off lump sums.

• If you pay off your mortgage using lump sums your lender may charge you a fee - this is because if you are on a fixed rate mortgage then your lender will have already priced in the interest you pay when they gave you the mortgage deal.

• If you choose to make regular overpayments on your mortgage you will also need to check with your lender whether you will be charged a fee.

• Most mortgage lenders will let you overpay up to 10% of the total amount owed in any one calendar year without charge. If you pay your mortgage off in full you will also have to check whether your lender charges an early mortgage redemption fee.

How should I pay off my mortgage early?

Take a look at your finances to work out if you have any surplus cash that you can use to pay down your mortgage, each month. 

If you can overpay, it's well worth doing. Say, for instance, you have £135,000 outstanding on your 25-year, 5.25% fixed rate mortgage. An overpayment of £100 a month would take your repayments from £809.98 to £909.98 a month. 

However, it would also cut 5 years off your mortgage term and save you more than £25,000 in interest, making overpaying an option that's definitely worth considering in your quest towards paying off your mortgage early.

You need to make it clear when you overpay whether you’d like to reduce your mortgage term or your monthly payouts. If you don’t, lenders might take that decision out of your hands leaving you with the less desirable outcome of the two.

• Check your mortgage terms and conditions to make sure overpayments are allowed

• Find out if overpayments now might entitle you to a mortgage holiday later, should you need it

If you’re wondering how to pay off your mortgage early, overpaying will definitely have a big impact on reducing your debt.

Paying off an interest only mortgage early

If you have an interest only mortgage, remember that paying extra each month might not make any difference to your overall mortgage debt. 

If you want to use savings to reduce your overall mortgage debt by making overpayments, you will need to either set money aside in a savings account or switch to a repayment mortgage. 

You should always, where possible, make sure you pay down both your mortgage interest and capital.

Is it worth paying off my mortgage early?

Yes It can be, especially if the amount of mortgage interest you’re paying is more than your savings would earn. For example, if you are paying 2% on mortgage interest but your savings are earning less than 1%.

Consider your pension before paying off your mortgage

Remember that money saved into a pension is tax free, so before repaying your mortgage, you may want to consider putting more into your pension. 

Money can be taken from your pension at age 55 or 57 depending on your terms and conditions, so if your pension fund is earning 5% interest and therefore making more interest than your mortgage is costing then it may be worth saving more into a pension and using that money if you still owe money on your mortgage when you gain access to your pension. 

You can get advice on your pension options at the Government website MoneyHelper

Should I use my savings to pay off my mortgage?

It's a good option if you would normally put money into a savings account every month as, even though you may not see any immediate difference in your monthly payments, reducing the overall mortgage debt will bring down your payments the next time interest rates are recalculated.

Also overpaying now will more than likely give you a bit of leeway with the lender if you find it harder to meet regular monthly payments later.

• You will still need to hold back some savings - ideally at least six months worth of bills and everyday household and living expenses

• Work out how much extra you can pay each month towards your mortgage while keeping some savings aside for emergencies

How to pay off your mortgage using an offset or current account mortgage

You can use an offset or current account mortgage to pay your mortgage off early. 

These provide something of a halfway house in that they offset your current and/or savings account balance against the amount owed on your mortgage.

Current account mortgages treat your home loan like one big overdraft, by rolling your current account and mortgage into a single financial product.

As your lender will deduct the balance held in your current account from your outstanding mortgage debt before they calculate your interest payments, this gives you the opportunity to reduce the total amount you need to repay.

However, while your interest payments will go down as your current account balance increases, it's important to remember that the reverse also applies. 

Consequently, the amount of interest you need to pay will increase as your current account balance decreases.

Offset mortgages work on the same principle however, the positive balances in your current and/or saving accounts are held separately and then linked to your mortgage.

These flexible accounts aren't suitable for all homeowners, but they can be a good option to consider if you want to reduce your overall mortgage balance while still having access to your savings.

What happens when you pay off your mortgage?

Early mortgage repayment is an option if you have a large amount of savings, making paying your mortgage off in full possible. 

This means that you then own the property outright. Obviously, this option depends on how big your mortgage is, what terms and conditions apply and how much you have tucked away in savings.

You will need to check your terms and conditions carefully before considering this route as you may be charged redemption penalties (usually a percentage of the amount you pay off). It is also vital to balance the security you will get from owning your home outright with the need to retain some savings to offer a safety net if your finances take a turn for the worse.

• Check the terms and conditions of your mortgage to see if a redemption penalty would be incurred, and how much it would be

• Don't overstretch yourself; retain some savings for a rainy day

Paying off a mortgage early - what else you need to know

Using your savings to pay off mortgage and tax

Savings income is taxed, with ISAs being the exception, and while the money you spend on mortgage payments is not, there is a potential tax benefit associated with paying off your mortgage, as opposed to putting your money in a savings account or even a pension where you get your income tax refunded (it is put into the pension fund).

Additionally, there is an annual interest allowance of £1,000 (or £500 for higher rate taxpayers) meaning you need to earn more than that in interest from savings before tax is applied.

• If you are unsure, check with an accountant to find out how your tax situation might be affected

Paying off debts before you pay off your mortgage

Before overpaying or paying off your mortgage, remember, even though the debt is usually very large, a mortgage is often one of the cheapest ways to borrow money so always aim to pay off high-interest debts first

If you have a credit card, personal loan or even an overdraft, it is worth considering paying them off before you even think about reducing your mortgage arrears. 

Credit or store cards in particular can often be the most expensive means of borrowing money, and personal loans are often more expensive than mortgages. Paying off expensive debts first will have a more immediate effect on your monthly finances.

As a general rule, the more expensive the debt in terms of interest rates, the greater the benefit you will get from paying it off quickly.

• Check all of your debts to see which is the most expensive in terms of interest and start there.

Making sure you pay off outstanding household bills first

Another option to consider is paying off any outstanding debts on your gas and electricity bills.  You don't pay interest on any outstanding balances, but your supplier will increase your monthly direct debit to ensure that any arrears are paid off over time - usually about 12 months. Clearing that balance will bring down your monthly payments, making you better off each month.

• Check your utility bills to see if you are paying off any outstanding balances with your monthly payments

Paying off mortgage early: pros and cons

You need to work out whether saving makes more sense for you than paying off debts - and it's a complicated question that must be considered properly (using expert help if required).

Think about whether a savings rate will make more money than you would save by paying off your mortgage or credit card. 

A lot will depend on your individual circumstances, for instance the size of your mortgage and the interest rate you pay on it (bearing in mind that any interest you pay is taxable, whilst mortgage payments are not).

Consider this: £10,000 worth of mortgage debt at 5% interest will cost you £500 a year in interest. Tax-free, the equivalent amount in savings would earn you £100 a year at 1% interest.

However, if you are a basic-rate taxpayer this will decrease to £80 of interest earned on your post-tax savings each year if you have passed the tax-free savings allowance. For higher rate taxpayers, the difference is even more pronounced with £10,000 in a 5% savings account offering a return of just £60 a year.

Compare this to the amount of interest you'll pay on your mortgage debt and, even if you only pay tax at the basic rate, you'd still be £400 better off by putting that £10,000 towards your mortgage.

But you need to be careful when sacrificing savings too. It might be a fine idea in the long run to save money on your mortgage rather than earn less in savings - but if you get an unexpected bill you could end up paying 20% interest on a credit card or 40% interest on an overdraft if you don’t have the free cash to cover it.

Of course a flexible or offset mortgage - which lets you reclaim any cash you overpay at a later date - removes this risk.