Extra cash to spend following the base rate cut? Here's why you should put it towards your mortgage repayments.
If you're lucky enough to be on a variable mortgage rate, odds are you've spent the last week gloating about last week's dramatic 1.5% base rate cut and the huge reduction forthcoming in your monthly mortgage payments.
After all, in the run up to Christmas, who wouldn't fancy some extra cash in their pocket?
But before you rush out and start spending, consider this: if - instead of spending the extra money - you maintain your mortgage payments at the level they were at before the base rate cut, you could pay off your mortgage years early.... and save yourself thousands of pounds of interest as well!
All for the same amount of money you were going to put towards your mortgage anyway, every month. So you won't even notice the difference in your bank account.
What about saving instead?
You could save the extra cash instead, that's true. But at a time when savings rates are rapidly declining, I think it makes more sense to pump more money into your mortgage. The long-term benefits really are huge.
What are the benefits?
To put it simply, time and money.
Let me explain.
Say you currently have nearly 23 years left to pay off your mortgage of £150,000. Your current monthly payment is £950 and your interest rate before the base rate cut was 5.5%.
Following the cut, your rate has now dropped to 4%, so your monthly payments fall from £950 to £830.
Now, you would probably be thinking: Woo-hoo! An extra £120 to spend every month.
But let's say you decide to put that extra £120 towards your mortgage - in effect, keeping your monthly payments level at £950 a month.
Thanks to your overpayment, the term of your mortgage would be reduced by more than 4 years, so you'd be mortgage-free in less than 19 years!
And you would save yourself nearly £16,000 in interest. Impressive huh?
You can see the savings for yourself by using our mortgage overpayment calculator.
Of course, if interest rates come down even further, which is looking likely, the savings you will make could be even greater. This does however depend on whether your lender has a `collar' on its tracker rates. This means there is a particular level beneath which your mortgage rate cannot fall, and if this is the case, some trackers may already be as low as they can go.
Will my lender allow me to make overpayments?
A lot of lenders do allow you to make overpayments, but some will slap you with hefty early repayment charges. So check with your lender whether you'll be penalised for making overpayments.
Even if you are allowed, there is usually a limit to how much you can overpay. Some lenders will only allow you to make overpayments of up to £500 per month for example, while others fix the limit at 10% a year.
Payment holidays
If you overpay now, some lenders will allow you to take a break from your monthly payments if you ever need to in the future. This is known as a 'payment holiday'. Your mortgage lender effectively draws down the overpayments you have made, so that you do not fall behind with your mortgage, even though you do not pay a penny that month.
With Britain set to slide into a recession, this could well come in handy one month when things get tight.
However, not every lender will allow a payment holiday so again, do double-check the small print.
Overall, when times are so uncertain, putting extra money towards your mortgage seems like a very sensible idea to me. Of course, if you have more pressing debts to pay off, then any money should be put towards those first. But if you are able to put your money towards paying off your mortgage early, it could potentially be one of the best financial decisions you ever make.
More: The Danger With Interest-Only Mortgages | The Right Mortgage: Discount Vs Trackers