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Homeowners who have money to save have faced a new dilemma with rising interest rates.
Are they putting the money in one of the best new savings accounts to be launched? Or are they trying to pay off part of their mortgage to keep the cost of their debt down?
Many households have built up a saving habit during the pandemic and are considering their next move.
Smart move? You can usually overpay your mortgage by 10% without penalty. You just need to contact your lender to get started
Here, Money Mail explains how to determine if overpaying on your mortgage is the right choice for you.
Trick to reduce the cost of your home loan
Not everyone knows that you can usually overpay your mortgage by 10 percent without a penalty.
It is not complicated to set up the payments. You only need to contact your lender if you want to get started.
Most usually make you overpay by a lump sum or increase your monthly payment.
If you don’t have any outstanding expensive credit and can tick the boxes in the panel, still, then it may be worth paying too much.
Makala Green, financial planner at Schroders Personal Wealth, says: ‘In the past, mortgages were seen as ‘good debt’, but now that interest rates are rising, they are effectively becoming expensive debt.
“Those with low mortgage rates should think about cutting at least some of it before moving on to a higher interest rate.”
The impact on your finances is greatest in the long run.
With mortgages, you inevitably pay back significantly more than you borrowed — and the higher the interest rate, the higher your total bill.
For example, if you had 20 years left on a £250,000 amortization mortgage at a 2 percent rate, you would end up paying back £303,530, including interest, according to broker L&C Mortgages’ amortization calculator.
Long-term benefit: With mortgages, you inevitably pay back significantly more than you borrowed – and the higher the interest, the higher your total bill
But if the rate were 4 percent, you’d repay £363,588 – a massive £113,588 on top of your original loan.
By paying off more of the debt in previous years, you reduce the size of the loan on which interest is charged.
For example, if you paid off an additional £200 per month on that £250,000 mortgage at a 2 percent rate for two years, you could save £2,184 in interest, according to an analysis by Interactive Investor. This saves five months from your total mortgage term.
With the same overpayment and mortgage at a 4 percent rate, you would save £5,339 in interest and shorten your mortgage by six months.
By paying too much early, you reduce the size of your debt, which in turn reduces the amount of interest you’re charged.
If interest rates continue to rise, you will save more interest by paying back your balance sooner.
Overpaid to unlock new rate
Overpaying your mortgage will help you pay what you owe much faster and may qualify for a lower loan-to-value (LTV) deal when your fixed rate ends.
LTV is the value of a home relative to the amount you have to borrow when refinancing.
This can unlock slightly lower rates. Virgin Money, for example, offers those who want to refinance 5.43 percent at 60 percent loan-to-value, compared to 5.94 percent for those who want 80 percent LTV.
Chanelle Pattinson, financial planner at Money Means, says, “Lenders view borrowers with lower LTVs as less risky, so they may offer slightly more favorable rates.”
If you only have a few years left on your mortgage, the impact of overpaying is less than if you start overpaying earlier.
You will not qualify for better LTV deals and the potential interest savings will be small. So if you’re nearing the end of your term, it may be worth turning the money into investments, pensions, or retirement savings.
Timetable: If you only have a few years left on your mortgage, the impact of overpaying will be less than if you start overpaying earlier
How to calculate the most important sums
Now the key question: should you pay off too much on the mortgage or save on a cash account?
First, check how your mortgage interest compares to the best savings deals on offer. Just as mortgage rates have risen, savings deals have become more attractive in recent months.
Suppose you have a mortgage interest rate of 2 percent and can get a low-threshold interest rate of 2.5 percent. If you put $200 a month in a savings account that pays 2.5 percent, you’ll earn $117 in interest in two years.
By comparison, if you overpaid £200 a month for two years on a £250,000 mortgage, tied at 2 percent, you would save yourself £93 in interest over the two years, but this would pay off by the end of the year. the 20 years add up to £2,184. year mortgage.
For the same mortgage set at 4 percent, making monthly overpayments of £200 over two years would save you £189 in interest, rising to £5,339 at the end of the mortgage term.
This means that the interest savings can be much higher if you have to take a higher interest rate in two years.
However, the expectation is that the interest on savings will not rise as quickly as the mortgage interest.
Most major lenders have a mortgage amortization calculator on their websites to crunch the numbers.
If you have a lump sum, the question is: do you pay off part of the mortgage or do you lock it in a fixed rate that may pay 5 percent? On a balance of £5,000 paying 5 percent over two years, you would receive £525 in interest.
If you paid a one-off £5,000 on your mortgage at a 2 percent rate, you’d save £195 in interest in two years, according to L&C Mortgages.
l.purkess@dailymail.co.uk
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