Now is the Time to Pay Off Your Mortgage Earlier?
Mortgage rates already held by homeowners average 1.05 pc, according to Hargreaves Lansdown, the fund store.
On a 25-year mortgage of Â£ 100,000 at this rate, overpaying a maximum of Â£ 10,000 each year would save around Â£ 9,600 in interest and pay off the entire loan in about eight years.
At today’s savings rate, putting that money into an easy-to-access account would only earn Â£ 540 in interest.
But investing money could generate significantly higher returns. Over eight years, Â£ 10,000 invested annually with an average return of 4pc would generate around Â£ 14,126.
At that rate of return, investing the money in cash would leave the homeowner Â£ 4,526 better than if they had used the money to make mortgage overpayments.
However, those with less equity in their home could benefit significantly from overpayments, often saving more in interest payments than they would in stocks and shares.
Mortgage lenders set higher rates for those with less equity, typically first-time buyers or those who have recently purchased their home, because they see it as a higher risk.
The five-year average fixed rate deal for borrowers with only a 10pc deposit is 3.24pc. Overpaying Â£ 10,000 a year on a Â£ 100,000 mortgage at this rate would save the borrower around Â£ 33,000 in interest payments and pay off the loan in about eight years.
To match this, an investment portfolio should return just over 8% over the same time period.
In addition to saving on interest paid, the homeowner would also be able to remortgage after five years with a deposit of 50pc, which would give them access to rates below 1pc.
Even paying too little can save a lot of money. For the example above, overpaying just Â£ 50 per month would save Â£ 6,855 over the life of the loan and pay off the mortgage three years and four months earlier.
However, borrowers should be careful that overpayments do not incur prepayment charges from their lender. Most banks and mortgage lenders allow borrowers to make overpayments of up to 10% per year, but this is not always the case.
A prepayment charge applies to both overpayments and the entire loan. Early repayment of the loan, usually within five years, will often incur costs, as will failure to meet the annual overpayment indemnity.