Many homeowners will long for the day when they’ll finally be mortgage-free. One way to try to move that day closer is to make overpayments on your mortgage. You can do this by paying off a sizable lump sum or by adding a little extra to your monthly payments when you can.
Though it may seem like a sensible move, many mortgage borrowers with extra cash will be faced with the question of whether it makes more sense to pay off their mortgage or transfer the funds to a high-yield savings account. This is because savings rates have finally started to yield significant returns.
As per Mark Harris, CEO of mortgage broker SPF Private Clients, “overpaying your mortgage reduces the debt you owe and the interest you pay over the term of the loan.” “It makes sense to use your savings to lower the interest on the mortgage if your mortgage rate is higher and your savings are earning very little interest.” ”.
Balancing mortgage payments and saving for retirement is a common dilemma faced by many homeowners. Both options offer distinct advantages, and the optimal choice depends on your individual circumstances and financial goals. This article delves into the intricacies of this decision, providing insights, tips, and strategies to help you navigate this crucial financial crossroads.
Exploring the Pros and Cons of Each Option:
Paying Extra on Your Mortgage:
Pros:
- Reduced Interest Payments: By making extra payments towards your mortgage principal, you effectively lower the amount of interest you’ll pay over the loan’s lifetime. This can translate into significant savings, especially in the early years of your mortgage when interest payments are highest.
- Faster Equity Buildup: With each extra payment, you chip away at the principal, increasing your equity in the property. This can provide you with greater financial flexibility and security, allowing you to tap into your home’s value for future needs.
- Psychological Benefits: Witnessing your mortgage balance dwindle faster can be a powerful motivator, providing a sense of accomplishment and progress towards financial freedom.
Cons:
- Limited Liquidity: Once you’ve put money towards your mortgage, it’s not readily accessible. This can be a drawback if you encounter unexpected expenses or financial emergencies.
- Opportunity Cost: By prioritizing your mortgage, you may miss out on potential investment opportunities that could offer higher returns.
- Tax Implications: In some countries, mortgage interest payments may be tax-deductible, making it less advantageous to pay off your mortgage early.
Saving for Retirement:
Pros:
- Long-Term Growth Potential: Investing in retirement accounts allows your money to grow over time through compounding interest. This can significantly boost your retirement savings, providing you with financial security in your later years.
- Flexibility: Retirement savings are typically more liquid than mortgage payments, allowing you to access your funds if needed.
- Tax Advantages: Many retirement accounts offer tax benefits, such as tax-deferred growth or tax-free withdrawals in retirement.
Cons:
- Market Volatility: Investments are subject to market fluctuations, which can lead to losses in the short term. This can be a concern if you need to access your retirement savings before they have had time to recover.
- Delayed Gratification: The benefits of retirement savings may not be realized for many years, making it less tangible than paying down your mortgage.
- Discipline Required: Saving for retirement requires consistent contributions and long-term commitment, which can be challenging for some individuals.
Factors to Consider When Making Your Decision:
- Interest Rate on Your Mortgage: If your mortgage interest rate is relatively low, it may make more sense to prioritize retirement savings. Conversely, if your interest rate is high, paying down your mortgage could be a more strategic move.
- Your Time Horizon: If you are nearing retirement, focusing on retirement savings becomes more crucial. However, if you have many years until retirement, you have more flexibility to allocate funds towards both goals.
- Your Risk Tolerance: If you are risk-averse, investing in retirement accounts may not be the best fit. In such cases, paying down your mortgage can provide a sense of security and stability.
- Your Financial Goals: Consider your overall financial goals, such as buying a vacation home or funding your children’s education. These goals may influence your decision on how to allocate your available funds.
Strategies for Balancing Both Options:
- Contribute to Retirement Accounts First: Aim to contribute the maximum amount allowed to your retirement accounts each year. This ensures you’re taking advantage of tax benefits and maximizing long-term growth potential.
- Make Extra Mortgage Payments When Possible: Once you’ve met your retirement savings goals, consider making extra payments towards your mortgage principal. This can help you pay off your loan faster and save on interest.
- Automate Your Savings: Set up automatic transfers from your checking account to your retirement accounts and mortgage payments. This ensures consistent contributions and minimizes the risk of falling behind on your financial goals.
- Seek Professional Advice: Consult with a financial advisor to create a personalized plan that aligns with your specific circumstances and financial objectives.
Deciding whether to pay extra on your mortgage or save for retirement is a personal choice. By carefully considering the pros and cons of each option, your financial goals, and your individual circumstances, you can make an informed decision that aligns with your long-term financial well-being. Remember, there’s no one-size-fits-all approach, and the best strategy is the one that fits your unique financial situation.
Have you done the maths?
The next crucial step is to determine whether it would be better to overpay your mortgage or put the money into savings. Taking some time to experiment with a mortgage overpayment calculator and observing the impact of adding additional funds to your mortgage could potentially assist you in making a more informed choice. Additionally, utilizing a savings interest calculator will help you determine the potential return on investment if you put the money into savings.
Generally speaking, there is a compelling case to be made for lowering your mortgage rather than holding onto cash if your rate is higher than the best savings rate available.
%E2%80%9D%20says%20Alan Lakey, director at Highclere Financial Services Ltd., that paying off the mortgage is generally a good idea because the interest on deposit accounts tends to be 2% below the mortgage base rate. As a result, the rate of return achieved by repaying the loan is higher than when depositing money in a savings account. He adds that people often derive psychological benefits from seeing their mortgage balance decrease more rapidly too.
On the other hand, if the circumstances are different and you have a low-rate mortgage while higher savings rates are available, you might be better off using the money to maximize the higher returns by putting it in a savings account. “The money can be used to make a lump sum overpayment at a later time, when the mortgage rate increases,” advises Lakey.
Do you already have savings or other debt?
Consider other aspects of your financial situation before rushing to check the interest rate on your mortgage and how it might compare to the best savings rates.
“It’s crucial to keep in mind that money that is overpaid is nearly hard to recover, so instead of putting everything into the mortgage, you should save money for a rainy day,” advises Harris.
Generally speaking, you should aim to have enough savings in your emergency fund to cover three months or more of your normal monthly expenses. The money should also be easy to access, in case you need it quickly. However, paying off your mortgage more quickly might not be the best course of action for your particular situation, even if you have already established a rainy day fund.
Harris continues, “It is not a good idea to overpay on your mortgage if you have an outstanding credit card debt or overdraft.” “With the latter, you will probably be paying a much higher interest rate while the mortgage rate is relatively lower.” Therefore, it makes sense to pay off the expensive debt first before turning your attention to cheaper debt. ”.
Pay Off Current Mortgage or Save Cash For a New House?
FAQ
Is it better to pay off mortgage or put money in savings?
Is it smart to pay extra on your mortgage?
What happens if I pay an extra $500 a month on my mortgage?
Is there a downside to paying off mortgage early?
Should you make extra mortgage payments?
Here are the advantages and disadvantages of making extra mortgage payments instead of focusing on investing: Interest savings: Making extra mortgage payments reduces the interest you pay over the life of the loan. You’ll save the most if you start as soon as you get a mortgage, which is when the bulk of your monthly payments goes toward interest.
What happens if you pay extra on a mortgage?
For example: Savings: By making extra mortgage payments, you may not be able to save as much as you normally would. Monthly payments: Paying extra on a mortgage doesn’t normally lower your monthly payment, so you’ll still need to keep that regular monthly payment in mind.
When should I pay extra on my mortgage?
You can make additional payments applied to your principal at the time your mortgage payment is normally due, or earlier. “Or you can do so at more frequent intervals during the year,” he says. Any time you pay extra on your mortgage, you need to indicate to your lender that the money should go toward loan principal — not interest.
Can you save money on interest if you pay off a mortgage?
Make that a lucky 13 payments each year, though, and you save $27,216 in interest overall. If you kicked in an extra $200 each month, you’d save $6,000 in 10 years, $50,745 in 22½ years—and you’d have the mortgage paid off, too. Saving money on interest is not the worst idea in the world.