I am one of the lucky ones who decided to take out a five-year mortgage with Nationwide in December 2021 at an interest rate of 0.94 percent. I have three years and three months left.
Over a period of four years prior to this, I made overpayments totaling £19,000.
I have since stopped overpaying as I believe my money would be better off in a savings account given the high interest rates currently on offer.
Should I withdraw the £19,000 from the overpayment reserve and put in a three-year fixed rate bond instead? I could earn about six percent interest on the money, and I could pay it back in my mortgage at the end of the term.
If my calculations are correct, $19,000, with interest at six percent over three years, should mature at $22,629.30, meaning I would earn $3,629.30, or just over $100 per month.
Useful for saving? Our reader thinks he might be able to pay off more money on his mortgage if he takes the money out, puts it in a high-interest savings deal, and then puts it back in with interest.
Nationwide allows an annual overpayment of 10 percent of the original loan, so in my case £25,000. Therefore, the £22,629.30 would fall below this, giving the money back without penalty.
I understand that my monthly mortgage payments would increase, but it would certainly be less than £100 a month – and the extra money would pay off the mortgage balance.
I initially set the overpayment amount to shorten the mortgage term, rather than increase my monthly payments. This means that I can keep my monthly mortgage payments the same and simply extend the mortgage term.
Are all the stars aligned here, or am I missing something? DJ, via email
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David Hollingworth replies: With interest rates soaring, headlines have rightly focused on borrowers taking on much higher interest rates than they are used to.
However, the full force of rate hikes has not hit all borrowers, and you are a good example of someone who has been lucky enough to hold on to the medium-term low.
As you acknowledge, this is largely a matter of timing. Nevertheless, you certainly made a good choice and your current deal suggests that you managed to intervene at the most opportune time.
It’s a good idea to think about how you can use the remaining three years of your low rate to your advantage
In fact, the base rate started rising just after you locked in the rate in December 2021, and has risen at every meeting since the break in September this year.
It’s a good idea to think about how you can use the remaining three years of your low rate to your advantage.
By planning for where current interest rates will end, you can transition into the higher interest rate environment that is likely to persist. Even if interest rates fall again by then, they are unlikely to return to the ultra-low levels seen in recent years.
Often it would be wise to think about overpaying the mortgage each month to reduce the principal balance more quickly.
Some borrowers will still prefer this approach to seeing the mortgage interest deduction, just as you have in the past.
Mortgage interest versus savings
However, the rapid rise in interest rates means that as mortgage payments rise, so does the amount savers can earn from the money they put away.
While overpaying the mortgage normally exceeds the return on savings, it now seems beneficial to save instead, as long as the savings rate can provide a better return than lowering the mortgage.
> View the latest savings rates for the best buy
Three-year, fixed-rate savings bonds can be found at around six percent. Even if taxes were paid on the interest, it would still represent a substantial improvement over reducing payments on a mortgage interest rate below 1 percent.
Like many lenders, Nationwide allows overpayments of up to 10 percent per year without charging early repayment fees.
But unlike others, the overpayments form an “overpayment reserve” and the borrower can decide whether to use it to reduce their monthly payments, or maintain the same level of payments but shorten the term of the mortgage.
You chose the latter option, so the reserve is still intact.
Can you borrow the money back?
The big question here is whether you can withdraw the excess money on your mortgage in cash and put it in a savings account.
In the past, mortgage lenders’ reserve facilities worked in a similar way to flexible mortgages, allowing the money to be ‘borrowed back’.
That loan-back facility may continue for some Nationwide customers, but they will be customers with older mortgage accounts, usually those taken out before March 2010.
Even if you hold on to your mortgage for all that time, switching to a new product will remove access to these facilities.
Mortgage Maze: There’s plenty to think about for this reader — including whether his bank will allow him to cash out the money he overpaid on his mortgage
The overpayment reserve has been built up because you have overpaid in recent years, and will remain in effect unless you have chosen to remove the reserve.
However, if you have taken out a new mortgage in 2021, as you say, it is likely that the reserve, rather than being available to borrow the full amount back in one go, may only be used to finance underpayments or extend the mortgage term to shorten.
If you pay too little, the reserve for overpayments is gradually depleted, causing the mortgage to increase.
The same mortgage interest rate would apply, so the principle of diverting the usual monthly mortgage payments into a savings account to earn a higher return after any taxes would still apply.
You can use the reserve to make your monthly payments and deposit the money you normally pay to Nationwide each month into your high-paying savings account.
However, if you pay too little, this is more of a drip and will affect the ability for you to lock in a favorable fixed savings rate on a fixed amount.
You should also keep an eye out for the best savings rates that allow for regular payments.
This will change your amounts slightly, but if you decide to proceed, you can contact Nationwide to confirm the level of your available overpayments reserve and understand the process required to enable underpayments.
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