If you’re lucky enough to have some spare cash available, you might be considering whether to use this to overpay your mortgage or save more into your pension.
As mortgage rates have risen in recent months, those with savings may decide to prioritise reducing their mortgage balance before they remortgage, rather than paying into their pension. However, both can be good financial options, and it really depends on what your priorities are, as no-one can be certain what the future holds for either interest rates or investment growth.
In this article, we look at the pros and cons of overpaying your mortgage and paying into your pension, and some of the factors that you might want to consider when deciding which of these options might be right for you.
If you’re considering getting professional financial advice, Unbiased is offering Rest Less members a free pension review. It’s a chance to have a qualified independent financial advisor (IFA) take a look at your pension arrangements and give an unbiased assessment of your retirement savings.
The review is free and without obligation, but if the IFA feels you’d benefit from paid financial advice, they’ll go over how that works and the charges involved.
Why top up your pension?
If you can afford to do so, paying extra money into your pension can be a financially savvy move. You’ll not only benefit from government tax relief on the amount you save but your pot will hopefully be boosted by investment gains over the long term (although there are no guarantees).
Pension tax relief essentially means that some of the money that you would have paid in tax to the government goes into your pension instead. For example, a basic-rate taxpayer receives 20% pension tax relief, meaning that they would only have to contribute £80 to their pension to benefit from £100 in their pension, with the government making up the rest.
Higher rate taxpayers receive 40% pension tax relief, and additional rate taxpayers receive 45%, so they would only need to pay £60 or £55 respectively to contribute £100 to their pensions. Read more in our article How pension tax relief works.
If you’re paying into a workplace pension scheme, you’ll also benefit from employer contributions into your pension as well as your own. Depending on your particular workplace pension rules, your employer may pay more into your pension if you increase your contributions. These contributions can significantly increase the value of your pension over time, and they will also be topped up by government tax relief.
You’re entitled to receive tax relief on up to a certain amount of pension contributions each tax year, known as your Annual Allowance. For the 2024/5 tax year, the Annual Allowance is £60,000. Read more in our article How do pension allowances work?
It’s usually a good idea to put money into your pension if you can afford to do so, while also considering your other financial priorities. However, remember that this money will be locked away until you reach age 55 in a defined contribution pension (rising to 57 in 2028).
Why overpay your mortgage?
Choosing to pay more towards your mortgage could save you thousands of pounds in interest charges and reduce your mortgage term, which can be particularly useful when mortgage rates are rising. You may also want to overpay to reduce your outstanding balance so that you own your home outright more quickly, giving you greater financial security.
For example, let’s say you pay £1,591 a month for a £150,000 repayment mortgage with 10 years left to run on a 5% fixed rate. If you paid £10,000 off your mortgage balance with a savings lump sum and continued to make the same monthly payments, this would reduce your mortgage term by three years and save you £22,185 in interest.
Despite fixed rates falling slightly in recent months, they remain significantly higher than they were, with two year fixed rates currently at around 6%. The average standard variable rate (SVR) meanwhile, which is the rate you normally automatically roll onto when your mortgage deal ends, has soared from 5.17% in August 2022 to 8.54% in April 2024, so overpaying your mortgage may particularly appeal at present.
Read more about how overpaying your mortgage works in our article Should I overpay my mortgage?. If you are currently on a high SVR or nearing the end of your fixed rate deal, check out our article Five good reasons to remortgage right now to learn more about the benefits of remortgaging as soon as you can.
Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage. If you’re looking for expert mortgage advice, you can speak to an independent mortgage broker with Unbiased. Every advisor you find through Unbiased will be FCA-regulated, qualified and unconnected to product providers – so they can offer you truly unbiased advice.
Should you overpay your mortgage or top up your pension?
There’s no one-size-fits-all answer, as both overpaying your mortgage and topping up your pension are sensible financial options, so you may decide to do both if you can afford to. Besides, no-one can be sure where interest rates or the market will move next, so it’s impossible to predict for certain which will be the better choice over the long term.
However, in simple terms, if market returns outstrip mortgage interest rate rises then your money will likely be better off in your pension. Then again, if mortgage rates remain high for many years, you could potentially save thousands of pounds in interest by overpaying your mortgage.
Below, we’ve included a few examples from online investment platform Interactive Investor (ii) that demonstrate how different mortgage and investment growth rates affect both options.
Each example assumes a 25-year £200,000 mortgage, but changes the interest rate on the mortgage and the rate of pension investment growth. The investment platform calculated whether paying an extra £200 a month into your pension straight away, or overpaying your mortgage by this amount first and only paying into your pension after your mortgage is paid off, would save you more over time.
Example 1
Let’s assume your mortgage interest rate is 6%, while you are receiving pension investment growth of 5%. In this case, overpaying your mortgage by £200 a month would mean you pay off your mortgage six years early. If, once your mortgage is paid off, you put the same amount you previously paid in mortgage repayments (£1,288 a month) into your pension for six years then, along with 20% pension tax relief, you’d end up with £165,901 extra in your pension.
However, now assume that, based on the same rates, you didn’t overpay your mortgage and put an extra £200 a month into your pension for the full 25 years. In this case, you’d end up with £148,877 in extra pension wealth – around £17,000 less than if you had overpaid your mortgage first and used the amount you used to spend on mortgage repayments to top up your pension.
Example 2
Let’s say that you now have a mortgage rate of 5% and pension investment growth of 6%. In this scenario, paying into the pension first wins out.
Overpaying your mortgage debt by £200 a month still ends the term six years early, but investing in your pension afterwards at the rate you were previously making repayments (£1,169 a month) now nets you £152,758 in extra pension wealth.
However, paying £200 into your pension each month for the full 25 years while paying off your mortgage at the usual rate is ultimately more beneficial, resulting in extra pension wealth of £173,248 – about £20,000 more.
Example 3
Finally, let’s assume that both your mortgage and investment growth share a rate of 6%.
As you might expect, the financial benefits end up being roughly equal overall. Overpaying your mortgage and then investing the previous mortgage payments each month (£1,288, as in example 1) now nets you £171,455 in extra pension wealth.
Putting the £200 straight into your pension each month instead with no overpayment does edge this out slightly, earning you £173,248 in extra wealth, or just under £2,000 more. But the difference is not nearly as significant.
Final thoughts
The above examples demonstrate that even one percentage point difference in mortgage rates or investment growth can make a massive difference to the amount you end up with overall.
However, Alice Guy, head of pensions and savings at Interactive Investor, said: “Without a crystal ball it’s difficult to say which is a better option as the outcome largely depends on the level of interest rates and stock market performance. Of course, in reality interest rates don’t remain static, and you may therefore decide to prioritise overpaying your mortgage or pension at different times.
“When it comes to money, it’s not always a simple calculation as psychology and financial priorities also come into play. For some of us, financial security is a huge priority and clearing the mortgage early can give us peace of mind in case we lose our job or our circumstances change.
“There’s also something to be said for keeping plugging away at investing and pension saving over the years. There’s always a danger that we can put off investing until the future, leaving us less time for investment compounding to work its magic. Life also has a habit of getting in the way of our best-laid plans so it can be risky to put off pension saving for the future.”
If you’re fortunate to have enough savings, remember that you could allocate a little to both options – it doesn’t have to be an either or decision.
If you’re looking for expert mortgage advice, you can speak to an independent mortgage broker with Unbiased. Every advisor you find through Unbiased will be FCA-regulated, qualified and unconnected to product providers – so they can offer you truly unbiased advice.
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