When it doesn’t pay to overpay on your mortgage

Borrowers on ultra-low tracker mortgages are being urged to stop overpaying and instead take advantage of some of the top savings deals.

Tracker deals have tumbled with Bank rate, which has fallen from 5.75% in November 2007 to an historic low of 0.5%. Last week the interest rate was held at that level for the fourth consecutive month.

A borrower who took out a Woolwich lifetime tracker in November 2007, which tracks at 0.17 percentage points above Bank rate, has seen their rate fall from 5.92% to just 0.67%. Monthly payments on a £200,000 interest-only deal would have fallen from £987 to just £112. Many borrowers in this position have decided to overpay on their mortgages.

The Council of Mortgage Lenders has estimated that the increase in repayments due to lower interest rates is around £400m a month.

However, while 80% of people overpaying still believe they are better off, according to a recent survey by the Co-operative Bank, some may in fact benefit more by investing the money instead as savings rates hit the 5% mark.

Barnsley building society now offers a five-year bond paying 5.1%, while you can also get a top two-year deal paying 4.5% from Newcastle building society. The best easy-access deals are now paying over 3%.

Using the above mortgage example, if you continued paying £987 a month for the next 12 months, you would have overpaid by £10,500, assuming Bank rate stays the same.

This would save only £32 in interest, according to calculations from L&C Mortgages, a broker.

However, you could place the extra £875 per month (the amount left after paying £112 for the mortgage) into an instant access account such as Birmingham Midshires’ 3.15% deal, for 12 months.

You would have £10,608 as a higher-rate taxpayer at the end of the year. This is £108 in interest — £76 more than overpaying the mortgage.

You could have made even more had you desposited all your mortgage savings since November 2007. Over that period, you would have saved a total of £7,300.

If you placed this into the Newcastle building society’s two-year fixed-rate bond paying 4.5%, a higher rate taxpayer would make £400 in interest over the two years.

If, instead, you decided to use the £7,300 to reduce your mortgage, you would save £98 in interest over the next two years, again assuming Bank rate stayed where it is over the period. You would therefore be £302 worse off.

However, the saving option only makes sense if you are on an ultra-low tracker rate. If you are looking to lock into a tracker today, you would be better off overpaying on the mortgage as the rates are worse for new customers.

The best tracker deal currently available is with HSBC, which tracks at Bank rate plus 2.24 points.

Your monthly repayments, on a £200,000 interest-only deal, would be £457. If we assume you could afford to pay £987 a month, as in our original example, you could overpay by £530 a month.

Over 12 months, your overpayments would be £6,360, but your mortgage balance would reduce by £6,440, according to L&C, saving you £80 in interest.

As a rule of thumb, you can work out if you would be better off overpaying than saving by finding the best savings deal and comparing that with the rate you are paying on your mortgage. If the mortgage rate is lower, you would be better off saving the money.

Remember to net the rate on the savings deal to work out how much you are actually making. For example, if your savings rate is 5%, as a higher-rate taxpayer, you would be paid 3% after tax.