Is it better to save or pay off a mortgage?

In an ideal world, your mortgage will be paid off well before retirement, giving you time to funnel some extra money into your pension savings and leaving you debt-free before you leave the workplace. In reality, it isn’t always that simple – people are buying homes later, and with 25 to 30-year terms being commonplace, it isn’t difficult to see how a lot of people could end up continuing to pay a mortgage in their retirement years. The date could be pushed back even further if the borrower has to dip into their property equity at any point, or if they increase their mortgage to work their way up the ladder.

While it’s perfectly possible to continue paying a mortgage in retirement – retirement interest-only mortgages, for example, are becoming increasingly common – you may have other ideas. Paying off a mortgage early can mean you pay less interest, as well as freeing up your disposable income, so it could be worth considering how you can go about it. For many, using their savings could be a wise decision.

If you’ve got a healthy savings balance in a standard savings account, putting it to work by paying down your mortgage could make a lot of sense. However, it depends on the amount of savings you’ve got and the rate of interest they’re earning, and likewise, your mortgage balance and its interest rate.

Typically speaking, it’s likely that your savings rate will be lower than your mortgage rate, which means you’ll be paying more in mortgage interest than you’ll be earning from your savings. In this case, using your savings to overpay your mortgage means you’ll be saving more in the long run – you’ll be reducing your mortgage balance, which means the resulting interest payments will be smaller, and you’ll also have the chance to pay off your mortgage early, reducing the number of years you pay interest for.

However if you fixed your mortgage during the period of ultra-low rates, you might now find that your savings rates are increasing and could well be above your mortgage rate, in which case it would be better to take advantage of the savings interest.

All in all, overpaying has the potential to shave thousands of pounds off the overall cost of your mortgage, so for many, using some of their savings in this way could be incredibly beneficial. However, the key word here is “some” – even if your savings interest rate is poor, it’s wise to keep at least a small chunk of your savings untouched. It’s typically recommended to have at least three months’ worth of income squirrelled away as savings in case of an emergency (ideally six months’ worth), which should be kept accessible, such as in an easy access account or high interest current account.

You’ll need to check your mortgage contract terms, too. If you’re on an introductory fixed, discount or tracker rate, it’s likely that you’ll only be able to overpay a certain amount each year (typically 10% of the mortgage balance) without paying an early repayment charge, but if you’re on a standard variable rate or term product, you may have more leeway to pay extra.

For those wary about completely losing access to their savings, there is an alternative. Offset mortgages still allow you to use your savings to help reduce your mortgage commitments, but in a slightly different way. You keep your savings in an account that’s linked to your mortgage, but rather than earning interest on it, the amount is used to “offset” your mortgage balance. So you pay interest on a smaller mortgage amount and could potentially repay the mortgage sooner. But, if you need to withdraw the savings at any point, you can.

This method is particularly suitable for those with a decent chunk of savings, though interest rates are often higher for offset mortgage deals, so it’s important to make sure it’ll pay off.

Another option could be using your savings to boost your deposit when it comes time to remortgage, which could reduce your loan-to-value (LTV) and therefore your repayments. And, if you continued to regularly overpay, you could benefit from paying the mortgage off even sooner.

This depends on the terms and conditions of your mortgage contract, and how much you have available to you in savings. A lot of mortgage lenders will let you set up a standing order so you can pay extra each month, which could be ideal for those who are using their disposable income to bring down their mortgage. Others will accept lump-sum payments on a more ad-hoc basis, perhaps if you get an annual bonus, or want to save up first to make sure you don’t need an extra financial buffer elsewhere.

Really, it’s up to you, but just make sure to find out when interest is calculated on your mortgage. If it’s daily then it doesn’t matter when you overpay as your monthly repayment (including interest) will be calculated on the lower balance, but if it’s monthly, annually or quarterly, you’ll need to make sure you overpay at the right time so as to not miss out on the interest savings.

For many people, the goal is to become mortgage-free, and being able to do so sooner could dramatically reduce the amount of interest you ultimately have to pay. But is there a disadvantage to paying off a mortgage?

Arguably, there’s no direct disadvantage to paying off a mortgage, but you need to make sure that you’re making the right financial decisions. For example, do you have other, more expensive debts that you could be paying off? Do you have a pension pot that you’re neglecting? If so, it could be worth focusing on these areas first to ensure your savings are being put to the best possible use.

For those already in retirement, using their pension funds to pay off a mortgage can be a popular option. This is particularly true for those who have an outstanding interest-only mortgage and have no means of repaying the balance, and/or those whose 25% tax-free lump sum is a significant amount. In this case, it’s essentially the same as using savings to repay a mortgage, but in this stage of life, it’s particularly important to exercise caution. You wouldn’t want to use too much of your pension funds to pay off the mortgage and then find you didn’t have enough to live on in retirement, so it’s vital to seek suitable advice before you take the plunge.

If you do decide to pay off your mortgage, great! The mortgage lender will remove its charge on your property and send you various documents to prove that fact. Once everything’s confirmed, you’ll own your home outright and will have no further obligation to your lender.