With savings accounts offering such rubbish rates, offset mortgages may provide the answer.
These are sorry days for savers, but it is still possible to earn as much as 8% on your money. No, really. Better still, it’s a safe way to save, because you’re paying down debt at the same time.
Naturally, there is a catch. You have to be a homeowner. Or more specifically, to have a mortgage. Using your savings to shrink your mortgage can be a far better use of your money than shoving it into a crummy deposit account paying 1% (don’t forget to pay down more expensive debts first, such as a credit or store card).
It won’t just save you money today, but for years afterwards. It might also knock years off your mortgage term.
I make that win-win-win, and it doesn’t stop there.
Pay it down!
There are two ways of using your savings to reduce your home loan. The first, and simplest, is to use any spare cash you have to overpay your mortgage.
Many mortgages now allow you overpay up to 5% or even 10% of your debt every year, without penalty. Not every mortgage allows this, especially if you are still in the introductory period of a fixed or discounted variable rate, so check your terms carefully.
Since mortgage rates are invariably higher than savings rates, you should be getting a better return on your money. But that’s not the only reason why overpaying your mortgage is such a clever thing to do.
The incredible shrinking mortgage
Say you have a £100,000 capital repayment mortgage on a standard variable rate (SVR) of 4% over a 20-year term. Your total monthly payment will be £613. If you have £10,000 in the bank, and use that to shrink your mortgage to £90,000, your monthly repayment will fall to £551. This instantly saves you £62 a month, or £744 a year.
And that’s only the beginning.
With the original deal, your total loan repayments would have been £45,435 over 20 years. By paying off a chunk of your mortgage today, your total interest repayments will fallen to £40,892.
Over the term of your deal, you will have saved £4,543 in interest.
[SPOTLIGHT]If your lender charges an SVR of 6% you will save even more interest - £7,194. Who says you don’t get anything on your savings these days?
Clear your mortgage early
Alternatively, you could make a regular monthly overpayment into your mortgage. With that £100,000 capital repayment mortgage at 4%, paying an extra £100 a month would reduce the total amount of interest you pay from £42,999 to £33,935. That’s an amazing £9,064 less.
You would also repay your mortgage after just 15 years and eight months - more than four years early.
The taxman hates this mortgage
There’s another reason why overpaying your mortgage can make more sense than taking out a savings account. If you’re a taxpayer, you will pay income tax on any savings held outside an ISA. This will be charged at either 20%, 40% or 50%, depending on your tax rate.
If you overpay your mortgage, there is no tax to pay. That’s because you are saving interest, rather than earning it. If your mortgage interest is charged at 4%, that’s the equivalent of a savings rate of 5% for 20% basic rate taxpayers, 6.67% for 40% higher rate taxpayers and 8% for 50% top rate taxpayers.
Even using your ISA allowance, you won’t get that. Once again, your money is rolling up its sleeves and getting to work. It’s a great and perfectly legal way to escape tax.
And if you are stuck on a really pricey SVR, say, 5% or 6%, you will be getting an even better equivalent savings rate.
On your marks, offset, go!
Overpaying your mortgage can be risky, if you need that money at a later date. The more flexible deals will allow you to borrow back any money you have overpaid. Check what your deal offers.
Instead of simply overpaying, you could take out an offset mortgage. This lets you use your savings to shrink your home loan, while retaining the freedom to dip into them at any time (although some lenders set limits on withdrawals).
Offset mortgages cost slightly more than standard deals, so you may still need £15,000 or £20,000 in savings to make them worthwhile. Chelsea Building Society offers a five-year fixed rate offset mortgage at 3.39% up to 70% loan-to-value (LTV), with a £1,495 arrangement fee.
Yorkshire Building Society offers a range of offset deals, including a five-year fix at 3.49% up to 75% LTV, 4.34% up to 85% LTV and 5.19% up to 90% LTV. All carry a £995 arrangement fee.
Slim your mortgage
Incredibly, there is another benefit to overpaying or offsetting. Low interest rates will not last forever. At some point, they will start rising - rapidly.
If you’ve still got a big fat mortgage to repay, things could look ugly. But if you have paid a chunk of it down you will be sitting pretty.
It’s a win-win-win-win-win world
Paying down your mortgage isn’t just a lifeline for savers, it also offers a safe haven for people who are too nervous to risk their money in today’s volatile stock markets.
It could help you build enough spare equity in your home to fund a move to a bigger property or shop around for a cheaper deal at a lower loan-to-value.
Incredibly, it could even allow you to retire earlier, by helping you clear your biggest debt.
I think that makes it win-win-win-win-win-win. By now, I’ve lost count.
More: Why I hate this mortgage | This scary new property blunder will ruin your life
At lovemoney.com, you can research all the best deals yourself using our online mortgage service, or speak directly to a whole-of-market, fee-free lovemoney.com broker. Call 0800 804 8045 or email mortgages@lovemoney.com for more help.
This article aims to give information, not advice. Always do your own research and/or seek out advice from an FSA-regulated broker (such as one of our brokers here at lovemoney.com), before acting on anything contained in this article.
Finally, we tend to only give the initial rate of a deal in our articles, but any deal which lasts for a shorter period than your mortgage term may revert to the lender's standard variable rate or a tracker rate when the deal ends. Before you take out a deal, you should always try to find out from your lender what its standard variable rate is and how it will be determined in the future. Make sure you take all this information into account when comparing different deals.
Your home or property may be repossessed if you do not keep up repayments on your mortgage.