save it or overpay your mortgage? – The Irish Times

With mortgage rates on the decline once more – recent figures from the Central Bank show that the average interest rate on new mortgages is now at its lowest since August 2023 – homeowners may be getting some element of relief on their repayments.

At the same time, deposit rates have finally started to edge upwards, with returns of 3 per cent a year now possible.

So, if you do find yourself with a bit of spare cash at the end of the month – even if it’s just €50 – should you boost your savings now that a decent return is finally on offer? Or should you be considering overpaying your mortgage instead?

Well, assuming you have an emergency fund in place – typically six months or so of expenses in an easy-to-access savings account – either option is going to be good. But, depending on your circumstances, overpaying might result in greater rewards. Here, we take a look at the options.

Boost your savings

Let’s say you have an extra €200 to save each month. If you put this into one of the better savings options available at the moment, such as 3 per cent with Bank of Ireland or AIB, after one year you’ll have €2,439.

If you keep putting the balance into a fixed-rate account (typically the rate on regular savings drops to a much lower rate after a year), after five years you’ll have accumulated about €28,000 after 10 years, or almost €66,000 after 20 years, thanks to the benefits of compound interest.

This means a return of about €18,000 on your money, although you will lose almost €6,000 of this in Dirt, which is applied at a rate of 33 per cent.

So could you do better by putting this against your mortgage?

Overpay your mortgage

Savings are twofold when you overpay a mortgage, a “double whammy” says Martina Hennessy, managing director of mortgage broker Doddl. This is because as your principal reduces, the amount of interest you are charged falls. And a falling principal also means a shorter term. The sooner the loan is repaid, the sooner you will no longer have monthly repayments.

“If you overpay in the early years of the mortgage, when you owe the most, it’s so effective,” she says. Describing interest as a “necessary evil”, Hennessy says what you should always be trying to do is “pay as little interest as possible”, and you can do this by overpaying.

Consider someone with an outstanding mortgage of €300,000, at a rate of 3.8 per cent, and 20 years of payments remaining. Their current monthly repayments are €1,786 and, if all stays the same, they will have an interest bill of €128,755 from now until the mortgage ends in July 2044.

If they add €200 to their repayment each month, however, the sums will look considerably different.

First of all, their monthly repayment will obviously jump to €1,986, meaning they will make an additional €41,200 in repayments over the outstanding term.

The benefits will outweigh this contribution, however. This is because by reducing the amount owed each month, known as the “capital”, our homeowner’s interest bill will drop by about €20,000.

Not only that, but they will also make considerable savings on the term of their mortgage. This will drop from 20 years to about 17 years and two months – which means that the mortgage is repaid by September 2041. Not having to repay a mortgage beyond that results in further savings of some €60,724.

So that €41,200 in extra payments from your monthly savings delivers a total benefit in excess of €80,000.

But what about if you have a lump sum you wish to put against your mortgage?

Let’s say you put €10,000 against the aforementioned mortgage this August. This would decrease your interest payments by about €11,000, and the term by 11 months – leading to further savings of almost €20,000.

If you could double that once-off payment to €20,000, your interest savings would be in excess of €21,000, while your term would shorten by 23 months, or almost two years – leading to further savings of about €41,000 as you won’t have a mortgage to repay during this time.

For those expecting to take out a mortgage in the near future, Hennessy’s tip is to keep the term down: after all, many new home buyers will now find that their mortgage is less than their rent.

“Challenge yourself and go five years less. That’s the starting point, when taking it out, don’t just go for a 35-year term. The difference on 30-35 years is huge,” she says.

Lower LTV

Another benefit of overpaying your mortgage is the impact it can have on your loan-to-value (LTV) ratio, or the amount outstanding on your loan as a proportion of the value of your property. While rising property prices can help in this respect, so too can overpaying your loan.

AIB, for example, offers cheaper rates for those with lower LTVs. It currently offers a one-year fixed rate for someone with a LTV of 80 per cent or more of 4.65 per cent but this shrinks to 4.55 per cent if your LTV is between 50 and 80 per cent.

From a financial perspective then, it looks like a no-brainer, if you have spare cash, to overpay your mortgage rather than save, as you get a much better bang for your buck.

However, it’s important to note that overpaying your mortgage has an opportunity cost: once you pay down that money, it’s much trickier to get it back. This can stop borrowers from overpaying altogether, says Hennessy.

“Some people are less likely to overpay when they know they can’t get it back out,” she says.

Yes, you could release equity on your mortgage if you ran into financial difficulties – but doing so is cumbersome. Much easier to just withdraw money from a savings account.

Moreover, if you have other outstanding debt, you may be better off paying this down rather than saving or overpaying your mortgage – particularly if it’s much more expensive credit card debt, or a car loan, for example.

All other things being equal, money expert Martin Lewis has a general rule of thumb: if your mortgage rate is about the same, or higher than your savings rate, then it makes sense to overpay.

How much can I overpay?

Depending on who your lender is, and what kind of a mortgage you’re on, you may find it easy to overpay – or not.

Typically, if you’re on a variable rate mortgage, such as a tracker, you can overpay to your heart’s desire (and your financial ability). If, however, you’re on a fixed rate, then historically, overpaying meant changing the terms of the mortgage and you would be penalised.

These days however, banks have become more flexible. With Bank of Ireland, for example, you can overpay 10 per cent of your normal monthly repayment – so €100, for example, if your repayment is €1,000 a month.

At PTSB, a spokeswoman says there is no limit on how much you can overpay each year, regardless of whether or not the mortgage is fixed or variable.

And at AIB, there is also an option to overpay. Last October, the bank introduced a new regime, which allows you to overpay by up to €5,000 each year when you’re on a fixed rate. But anything over this might result in a penalty.

Its subsidiary, EBS, and its broker arm, Haven, however, have gone the other way; since January of this year, you can no longer notify either lender to increase your mortgage repayments. Instead, you can reduce your term, which will increase your monthly repayments and reduce the interest you pay.

The downside of this approach, however, is that it is much less flexible than simply overpaying month by month – what if it turns out that you need that extra money and have to extend the term again?

If you’re on a fixed rate with Avant, you can’t overpay each month. But you can pay a lump sum each year to the value of 10 per cent of the outstanding mortgage.

Watch out also, if you’re overpaying your mortgage to bring down the term, that if this means early repayment of the loan, it might mean you are breaking out of your fixed rate, and a charge could apply.

A tip from Hennessy: if you have firm plans to overpay but want the lower rate or the certainty of a fixed rate, consider splitting your loan. You could put 80 per cent on a fixed rate, and 20 per cent on variable, and then focus on paying down the element on the variable rate. Most lenders will allow this, she says.

Finally, if you want to work out how much you could save, Hennessy suggests checking out moneysavingexpert.com to run the numbers.