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Listen nowMortgage overpayments vs savings: what's the best option for your cash?
Find out whether overpaying your mortgage could be a better bet than opting for
a top-rate savings account
With interest rates hitting heights not seen for years, overpaying on your mortgage is a tempting move that could save you tens of thousands in the long run.
Having the extra cash available to make overpayments isn't something open to everyone in the cost of living crisis, yet even small increases to your repayments can make a difference.
In the past week, NatWest has doubled its annual overpayment allowance to 20% - meaning mortgage-holders can chip away further into their loans without triggering an early repayment penalty (ERC).
Here, Which? explores whether it's better to tuck money away in savings accounts or use that cash to overpay on your mortgage. We also delve into the pros and cons of overpayments and show how much interest you could avoid.
NatWest to double mortgage overpayment allowance
NatWest has announced it will increase its annual mortgage overpayment limit from 10% to 20% from next month.
Mortgage customers on fixed or tracker deals can take advantage of the offer, which allows them to overpay twice as much on their home loan.
For example, a borrower with £200,000 left on their mortgage will be able to overpay by £40,000 a year rather than £20,000, before being hit with an early repayment charge (more on this below).
NatWest says it will write to those who make regular overpayments of more than £500 per month, or who use eight to 10% of their allowance each year, to inform them of the rule change.
Why consider overpayments?
The increased limit is positive news for homeowners eager to build up a greater equity stake in their home before their current fixed-term deal comes to an end.
As mortgage rates have soared over the past year, borrowers will be met with huge payments leaps when they come to get a new deal.
The Office for National Statistics (ONS) says more than 1.4 million fixed-rate deals will end this year, and 57% of those ending are on rates below 2%.
As the average two-year fix currently stands at 5.33%, the majority of those remortgaging will be met with rates that are double, or even triple their current deal.
Therefore, homeowners with spare cash who are coming up to remortgage could consider overpaying on their current deal. Doing so would increase their equity - that is, the proportion of their home that they own - meaning they can benefit from lower interest rates when having to get on a new deal, as it will be at a lower loan to value (LTV).
- Find out more: best mortgage rates for home movers and first-time buyers
What is an early repayment charge?
An early repayment charge (EPC) is a penalty imposed by your mortgage provider if you overpay on your mortgage by more than they allow, or pay off the whole loan too early - this tends to be the case if you move house and can't port your mortgage to the new property.
The extent of the penalty varies depending on the lender. It is usually a percentage of the outstanding mortgage - typically between 1% and 5%.
Usually, an EPC is incurred when borrowers overpay by more than 10% a year.
While that is by far the most common limit, some lenders set their limits at 5%, and others place a blanket cash limit on how much you can overpay by - such as £500 a month. Some deals do not allow any overpayments.
- Find out more: mortgage types explained
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Join Which? MoneyOverpay or save: what to do with a lump sum?
Homeowners who've come into some money could look to use the cash by paying it into a savings account or to overpay on their mortgage.
Currently, the best one-year fixed-term savings accounts pays 4.16% AER, meaning that £5,000 would gain around £212 in interest once the year is up.
It's possible to get better returns, but you'll need to lock your money away for longer.
The table below shows the top rate of interest you can currently get on fixed-term savings accounts, in order of term.
| Account | AER | Est. interest on £2,500 deposit | Est. interest on £5,000 deposit |
|---|---|---|---|
| İşbank five-year fixed-term savings account | 4.5% | £629 | £1,258 |
| Union Bank of India four-year fixed-term savings account | 4.45% | £486 | £972 |
| Union Bank of India three-year fixed-term savings account | 4.4% | £352 | £704 |
| Union Bank of India two-year fixed-term savings account | 4.35% | £226 | £435 |
| Castle Trust Bank one-year fixed-term savings account | 4.16% | £106 | £212 |
Source: Moneyfacts. Correct as of 16 February 2023, but rates are subject to change.
Now let's see what could happen if you used the same lump sums to overpay your mortgage.
If you had 25 years left on a £200,000 mortgage with an interest rate of 5.3% (the current average rate for a two-year fix), you could theoretically make the following savings:
| Lump sum overpayment | Approx. money saved on interest | Number of months cut from mortgage term |
|---|---|---|
| £2,500 | £6,808 | 7 |
| £5,000 | £13,309 | 15 |
| £10,000 | £25,466 | 29 |
- Find out more: how to find the best savings account
How much difference do monthly overpayments make?
Not everybody has thousands of pounds to save or spend in one go, so monthly overpayments are another option to consider.
With interest rates as they currently are, depositing even just a little extra each month can make a big difference.
The table below shows how much you could theoretically save if you overpaid a set amount each month. We've calculated the figures based on a £200,000 mortgage with a 25-year term and interest rate of 5.3%.
| Monthly overpayment | Total amount saved over mortgage term | Time taken off mortgage term |
|---|---|---|
| £10 | £3,173 | 5 months |
| £50 | £14,618 | 1 year, 11 months |
| £100 | £26,645 | 3 years, 7 months |
| £150 | £36,741 | 5 years |
| £200 | £45,355 | 6 years, 3 months |
The interest you pay will vary depending on the deal you've signed up to and the length of your fixed term. But the above table sheds light on how extra overpayments can make a substantial difference.
In reality, you might find that it's not possible to consistently commit to the extra payment each month.
The vast majority of mortgages allow you to make ad-hoc overpayments on a monthly basis or as a lump sum - so if you want to pay an extra £200 one month, and nothing extra the next, and £50 the month after, you may be able to do so.
- Find out more: what to do if you need to remortgage
Mortgage overpayment calculator
Our mortgage overpayment calculator can help you get a broad idea of how your extra payments could impact your loan.
To get started, enter your balance, term, interest rate and proposed overpayment below.
For an accurate picture of how overpaying could affect your balance and term, speak to your mortgage lender.
Assess your finances before overpaying
You can save yourself thousands by making overpayments on your mortgage, but this decision should not be taken lightly.
It's really important not to leave yourself short of cash as once you've spent the money on your mortgage you won't be able to get it back (short of remortgaging to release equity further down the road).
With this in mind, any spare cash you have should first be prioritised for paying off expensive debts such as personal loans or credit cards.
The next important consideration is making sure you've got a suitable amount of cash to cover any unexpected expenses that may crop up be that replacing a broken boiler, or paying out for car repairs. This is known as an emergency fund and should cover at least three months of essential expenses. It's best to have the money in an account where you can access it whenever you need it.
Depending on your circumstances, you may also find there are other beneficial ways of spending extra cash, such as paying into your pension instead.
