Mortgage Overpayment vs. Savings: What Should You Do with Spare Cash in 2026?
 |
| Mortgage Overpayment vs. Savings |
You have managed to save a bit of extra money at the end of the month. Now comes the classic financial dilemma:
- Option A: Overpay your mortgage to clear the debt faster.
- Option B: Put the money into a high-interest savings account.
With interest rates stabilizing in early 2026, the answer isn't as simple as it used to be. Often, savings rates are now higher than fixed mortgage rates. The decision depends on three critical factors: The Interest Rate Differential, Tax Rules, and Liquidity.
Let’s crunch the numbers to help you decide.
1. The Golden Rule: Compare the Rates
The starting point is simple math. You need to compare the interest rate you are paying on your debt vs. the interest rate you are earning on your savings.
- Scenario 1 (The Old Days): Mortgage Rate (5%) > Savings Rate (4%).
Verdict: Pay the Mortgage. Every pound you overpay saves you 5% interest. That is a guaranteed, risk-free return. - Scenario 2 (The 2026 Reality): Mortgage Rate (3.8% Fixed) < Savings Rate (4.5%).
Verdict: Save the Money. You earn more interest from the bank than the bank charges you. It makes mathematical sense to keep the cash.
However, this simple math ignores a huge hidden cost: Tax.
2. The "Tax Trap" (Personal Savings Allowance)
The interest you save on a mortgage is Tax-Free. The interest you earn in a savings account is Taxable (once you breach your allowance).
In the UK, the Personal Savings Allowance (PSA) has been frozen for years:
- Basic Rate Taxpayers (20%): £1,000 allowance.
- Higher Rate Taxpayers (40%): £500 allowance.
- Additional Rate Taxpayers (45%): £0 allowance.
⚠️ The "Higher Rate" Warning
If you earn over £50,270 a year (Higher Rate taxpayer), your allowance is only £500. With savings rates at 4.5%, you only need about £11,000 in the bank to hit this limit.
Any interest earned above that is taxed at 40%. So, a 4.5% savings rate effectively becomes 2.7% after tax.
The Real Comparison: If your mortgage is 3.8% and your savings (after tax) is 2.7%, OVERPAYING THE MORTGAGE WINS.
3. The Solution: Use Your ISA Allowance First
Before you overpay your mortgage, max out your Cash ISA.
Interest earned in an ISA is 100% tax-free forever. If you can get a Cash ISA paying 4.2% and your mortgage is 3.8%, you are better off saving in the ISA. Only consider overpaying the mortgage once your £20,000 ISA allowance is full.
4. The Power of Overpayment (The Compounding Effect)
If you do decide to overpay, the long-term benefits are massive because it shortens your term.
Example:
- Mortgage: £200,000 remaining.
- Rate: 4.5% interest.
- Term: 20 years left.
- Action: You overpay £200 per month.
The Result:
- You will pay off your mortgage 4 years and 3 months early.
- You will save approximately £24,000 in interest payments.
5. The Early Repayment Charge (ERC) Trap
Most fixed-rate mortgages have a limit on how much you can overpay each year (usually 10% of the outstanding balance).
If you overpay more than this 10% limit, the bank will slap you with a heavy Early Repayment Charge (ERC), which can be 1% to 5% of the amount. Always check your offer letter.
The Hybrid Strategy: Best of Both Worlds
Mathematically, if you can get a higher rate in an ISA than your mortgage rate, saving is smarter.
Psychologically, however, nothing beats the feeling of being debt-free and owning your home outright.
My Advice: Do both. Max out your tax-free ISA allowance first (for liquidity and high rates), and if you still have spare cash, overpay the mortgage to chip away at the debt. That way, you have a safety net and a faster route to freedom.
0 Comments