Homeowners with excess money to save face a new dilemma as interest rates rise.
Put the money in one of the newly introduced top savings accounts? Or are they trying to pay off part of their mortgage to keep the cost of their debt down?
Many households have developed a savings habit during the pandemic and are considering their next move.
Here we explain how to find out if overpaying your mortgage is the right choice for you.
Smart move? You can usually overpay your mortgage by 10% each year without penalty. You only need to contact your lender when you want to start
Trick to lower your borrowing costs
Not everyone knows that you can usually overpay your mortgage by 10 percent each year without penalty.
It's not complicated to set up payments. You only need to contact your lender if you want to get started.
In most cases, you can usually overpay a single lump sum or increase your monthly payment.
If you don't have an outstanding expensive loan and can check the boxes in the panel, it might be worth considering an overpayment.
Makala Green, financial planner at Schroders Personal Wealth, says: "In the past, mortgages have been seen as 'good debt', but as interest rates rise they are actually becoming expensive debt.
"Those with low mortgage rates should think about reducing at least some of them before moving to a higher rate."
The impact on your finances will be 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 have 20 years left on a mortgage with a repayment of 250.000 £ left at an interest rate of 2 percent, you would end up with a total of 303.Pay back £530, including interest, according to This is Money's mortgage calculator.
But if the interest rate were 4 percent, you would 363.Repay £588 – huge 113.588 £ in addition to your original loan.
Long-term benefit: With mortgages, you inevitably end up paying back significantly more than you borrowed – and the higher the interest rate, the higher your overall bill
Mortgage and savings calculator
By paying off more debt in earlier years, you reduce the amount of the loan on which interest is charged.
For example, if you put an extra £ 200 per month for two years on this 250.000 £ mortgage with an interest rate of 2 percent pay off, you could, according to an analysis of Interactive Investor 2.Save £184 in interest. This will shorten your total mortgage term by five months.
With the same overpayment and mortgage with an interest rate of 4 percent, you would owe 5.Save £339 in interest and shorten your mortgage by six months.
By overpaying early, you reduce the amount you owe, which in turn lowers the amount of interest you are charged.
If rates continue to rise, save more interest by paying down your balance sooner.
Overpay to unlock new rate
By overpaying your mortgage, you'll pay off your debt much faster and could qualify for a lower loan-to-value (LTV) deal when your fixed rate ends.
LTV is the value of a home compared to the amount you need to borrow in a debt restructuring.
This can unlock slightly lower rates. For example, Virgin Money offers 5.43 per cent at a 60 per cent LTV to those looking to restructure their debt, compared to 5.94 per cent for those wanting an 80 per cent LTV.
Chanelle Pattinson, financial planner at Money Means, says: "Lenders see borrowers with lower LTVs as less risky and so may offer slightly lower interest rates."
If your mortgage has only a few years left, the effects of overpayment are less than if you start overpaying sooner.
You don't qualify for better LTV offers and the potential interest savings are small. So if you're near the end of your term, it may be more worthwhile to divert the money into investments, pensions or retirement savings.
You can check the best interest rates you could apply for based on your mortgage size and property value with This is Money's best mortgage rate calculator.
Timescale: If your mortgage only has a few years left, the impact of an overpayment will be less than if you start overpaying sooner
How to calculate mortgage and savings
Now to the key question: should the mortgage be overpaid or saved in a demand deposit account?
First check how your mortgage interest rate compares to the best savings offers on offer. Just as mortgage rates have risen, savings offers have also become more attractive in recent months.
Assume you have a mortgage rate of 2 per cent and can get an easily accessible rate of 2.5 per cent. If you put £200 a month into a savings account with 2.5% interest, you would earn £117 in interest over two years.
In comparison, if you pay £200 per month for two years of a mortgage of 250.000 £, which is set at 2 percent, you would be overpaying by £93 in interest over the two years, but this would be reduced by the end of the 20. Century to 2.184 £ accelerate -year mortgage.
For the same mortgage, which is set at 4 percent, you would save £189 in interest over two years on a monthly overpayment of £200, which would rise to 5 by the end of the mortgage term in.£339.
This means the interest savings could be much higher if you are forced to accept a higher interest rate in two years' time.
However, savings interest rates are not likely to rise as quickly as mortgage interest rates. Most major lenders have a mortgage repayment calculator on their websites to crunch the numbers. This is Money's calculators can also help you:
If you have a lump sum, the question is: do you pay off part of the mortgage or do you put it into a fixed rate that may pay out 5 percent?
With a balance of 5.000 £ paying 5 percent over two years, you would receive £ 525 interest on.
If you have a one-time lump sum of 5.If you had paid £000 on your mortgage with an interest rate of 2 percent, you would save £195 in interest over two years, according to L&C Mortgages.
Some links in this article may be affiliate links. If you click on it, we receive possibly a small commission. This helps us finance This Is Money and use it for free. We don't write articles to promote products. We do not allow a business relationship to compromise our editorial independence.