Overpaying Your Mortgage vs Saving: What’s Best?

Yesterday we were exploring the benefits of how overpaying your mortgage can save you thousand of pounds and made emphasis in how important is as we are approaching the start of the new year to plan our finances for 2025. One of the biggest things to plan is our mortgage and our savings, and sometimes it comes the key doubt about if it is better to overpay the mortgage or to save the money instead.

Most of the mortgage lenders offer their clients to make overpayments each year free of charge within an allowance (a percentage of the total debt). That period when you can do those overpayments depends on the lender, so you need to check your mortgage documentation.

As said, once the window to overpay is open, one of the most common dilemmas people face is deciding whether to overpay their mortgage or allocate excess funds into a savings account. Both options have their advantages, and the right choice often depends on individual circumstances such as financial goals, mortgage terms, and current interest rates. On this article we will explore the advantages and disadvantages of both options, and at the end we will compare overpaying a mortgage vs saving money with the purpose of helping you make an informed decision.

The Case for Overpaying Your Mortgage

Overpaying your mortgage means making payments above your required monthly amount. This can reduce the total interest you pay over the life of the loan and shorten the repayment term. Here are the primary benefits and considerations:

Advantages of Overpaying Your Mortgage

1. Interest Savings Mortgage interest can be one of the most significant expenses in a household budget. By overpaying, you reduce the principal balance faster, meaning less interest accrues over time. This is particularly advantageous if your mortgage has a high interest rate. In the sample from yesterday’s post about how overpaying your mortgage can save you thousands, using a mortgage of £200,000 for 25 years at 4.5% was £133,333 of interest to pay on top. The month was £1,111 from which ~£750 is interest, so unless, thing about this.
2. Reduced Loan Term Overpayments can significantly shorten your mortgage term. For example, a 25-year mortgage could be paid off in 20 years or less, providing financial freedom earlier than planned. Based on above example, making an overpayment of just £365 (£1 per day), is knocking off one month of the full term.
3. Guaranteed Return on Investment The money you save on mortgage interest provides a guaranteed return. If your mortgage interest rate is 5%, overpaying is equivalent to earning a risk-free 5% return—a rarity in most investment markets. So let’s say that you overpay £200 each month just in 2025 making a total of £2,400 for the full year. Assuming you have left in your mortgage 20 years yet, you are really making a return on your £2,400 of ~£2,400 (£2,400 @ 5% x 20 years) over the life of the mortgage!
4. Psychological Benefits Paying off your mortgage early can offer peace of mind and a sense of financial security. Being debt-free is a goal for many and can significantly reduce financial stress.

Considerations Before Overpaying

1. Early Repayment Charges (ERCs) Some mortgages impose penalties for overpaying above a certain limit. That means that if they let you overpay up to 10% of your total balance, when you go over that limit they charge you as a sample 3% on the amount above. Sample:
   • Mortgage balance at January 1st, 2025: £164,584
   • Overpayment allowance of 10%, so that would be 10% of mortgage balance, £16,458.40
   • You make an overpayment of £20,000.
   • Early Repayment Charges (ERC) of 3%
   • As your overpayment (£20,000) goes above your overpayment allowance (£16,458.40), the sum over your allowance will have an early repayment charge (ERC) of 3%, so that is £20,000 – £16,458.40 = £3,541.60 @ 3% (ERC) = £106.25.
   As usually, we recommend you check your mortgage terms to understand whether ERCs apply, at which rate and which date they are recording the balance for your annual allowance.
2. Opportunity Cost Money used to overpay your mortgage cannot be invested elsewhere. If other investments or savings accounts offer higher returns than your mortgage interest rate, you might be better off allocating funds there, but we will have a look on this at the end of the post.
3. Liquidity Concerns Overpaying reduces your cash reserves. In case of emergencies, accessing the money tied up in your property can be challenging without resorting to loans or selling the house. We already explained how ourselves plan finances and estimated expenses over the year and how important it is.

The Case for Saving Your Money

In the other side, building a robust savings account is another option for those with extra funds. We know that savings accounts provide liquidity, financial security, and potential for growth. Let’s see the benefits and drawbacks:

Advantages of Putting Money in a Savings Account

1. Liquidity and Flexibility Savings accounts offer easy access to your funds, which is crucial for handling unexpected expenses, such as urgent home repairs.
2. Emergency Fund Financial advisors generally recommend having three to six months’ worth of living expenses saved in an accessible account. Before overpaying your mortgage, ensure your emergency fund is adequate.
3. Interest Earnings While savings account rates are often lower than mortgage rates, some high-interest accounts or fixed-term savings products can offer competitive returns. Additionally, savings interest rates may increase in a rising-rate environment.
4. Diversification Keeping money in a savings account allows you to diversify your financial portfolio. Instead of tying all your funds to your mortgage, you retain the option to invest or use the money elsewhere.

Considerations Before Saving

1. Low Interest Rates Savings accounts typically offer lower returns than mortgage rates. If your mortgage interest rate is higher than the rate offered by a savings account, you might lose money in real terms by saving instead of overpaying.
2. Inflation Risk Inflation erodes the purchasing power of money held in savings accounts. If the savings rate does not keep pace with inflation, the real value of your savings diminishes over time. This is something that a lot of people doesn’t realise. Having £10,000 in a saving account offering 2% might look good as you get £200 in interest, however with recent high inflation rates of ~10%, your £10,200 can only buy what before was costing £9180.
3. Discipline and Spending Temptation Unlike funds used to overpay a mortgage, money in a savings account may tempt some people to spend rather than save or invest. There are already some famous strategies to save money that we have discussed on previous posts.

The numbers

To make it easier to understand (that is what we hope!) let’s consider someone with a mortgage of £150,000 at a rate of 3.8%. That person has some extra cash (£10,000) and is thinking in making an overpayment although is unsure if it would be better to put the money in the saving account instead. By overpaying £10,000, he would save approximately £379 annually in interest. However, if they instead deposit £10,000 into a Cash ISA earning 4.5%, they earn £450 in interest per year. In this scenario, saving in the Cash ISA provides a higher return than overpaying. Note that we have mentioned Cash ISA, depending on the year’s allowance you might be taxed your interest, so we did a little UK tax guide with extra information.

How you can calculate if it is better to overpay your mortgage or save money. You need the following:

• Cash available, e.g. £10,000
• Offered saving rate, e.g. 2.9%
• Current mortgage rate, e.g. 5.4%

The calculations would be as follows:

• Option ‘Saving into a saving account’:
  Cash available (£10,000) x Offered Saving rate (2.9%) = £290
• Option ‘Overpay my mortgage’:
  Cash available (£10,000) x Current mortgage rate (5.4%) = £540

For tailored advice, you should consider consulting a financial advisor who can help you weigh the pros and cons specific to your personal circumstances. Whatever path you choose, but like we always say, the important thing is that your money works effectively towards securing your financial future.