by Vicky Monroe
When someone is trying to pay off their mortgage early, they usually choose a shorter loan term or make additional principal payments to speed things up. I started making monthly mortgage overpayments as soon as I bought my house a year and a half ago. So far I’ve knocked about $20,000 off my mortgage balance using this method, but I’m thinking about changing up my payoff strategy due to the looming threat of a recession.
A few weeks ago I read an article from Forbes about a different way to pay off your mortgage early to reduce your risk. Instead of paying the bank extra money, you deposit the cash you would’ve spent on mortgage overpayments into a high-interest savings account. This prevents your money from being locked in “equity jail” where you can’t easily liquidate it. Then when you accumulate enough cash to pay off your mortgage, you simply write a check for the full balance. However, there are some pros and cons to this method.
Pros and Cons of Stashing Mortgage Overpayments in Savings
The biggest benefit of stashing your mortgage overpayments in a savings account is that you maintain control over your money. When you make mortgage overpayments to your lender, your cash gets tied up in your mortgage. To access your money in the event of an emergency, you’d have to do a cash-out refinance or get a HELOC, which isn’t always possible. For example, if you lose your job, you probably won’t be able to find a lender willing to refinance your property.
But if you put the money earmarked for mortgage overpayments in a savings account instead, you’ll be able to pull from it when necessary. If you get laid off or fall ill and deplete your emergency fund, your mortgage savings will provide an extra safety net. That way you can still pay your bills no matter what happens. This added liquidity reduces the chances that you’ll foreclose on your house if you fall on hard times.
Higher Risk of Wasting Your Money
However, because your money will be easier to access, it will also be easier to waste. If you have $50,000 sitting in your bank account, it may make you feel extra flush. I know I feel richer when I have a high savings balance, which makes me think I can afford extra splurges. Many people make mortgage overpayments because it’s a form of forced savings. Since you can’t tap your equity easily, you can’t fritter that money away on unnecessary purchases.
To prevent this from happening, you should keep your mortgage savings in a separate bank account and pretend the money isn’t there. Otherwise you may end up blowing some of the cash and jeopardizing your early mortgage payoff goals.
Higher Interest Costs
Another downside of stashing your mortgage overpayments in a savings account is that you may pay more interest over the life of your loan. I ran the numbers and compared the interest costs you’d incur if you made monthly overpayments versus one lump sum.
The scenario I used was a $200,000 mortgage with a 4% interest rate and a 30-year term that’s paid off in five years. Assuming my math is correct, you’d pay about $17,300 more in interest if you saved your overpayments instead of applying them to your mortgage balance monthly. In the grand scheme of things, this isn’t a ton of money, but it’s still worth keeping in mind.
Saving My Mortgage Overpayments For Now
Paying off your mortgage is viewed as a low-risk financial strategy compared to investing in the stock market. But since I’m pretty conservative when it comes to money management, I’m always looking for ways to reduce my risk even more. That’s why I’m drawn to this strategy of saving my mortgage overpayments in a bank account to provide an extra layer of financial security and liquidity.
I’m planning to implement this strategy at least until this upcoming recession is over. You never know how long it will take to find a job if you get laid off at the height of a recession. So having additional money on hand in case of emergency is never a bad thing when a downturn is on the horizon. Once the economy bounces back, I may reevaluate this strategy. After all, I don’t want to pay more interest if I don’t have to, or risk wasting my mortgage savings because they’re easily accessible.
What do you think of this mortgage overpayment method? Would you use this type of strategy to pay off your debt? Share your thoughts in the comments below!
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Vicky Monroe is a freelance personal finance and lifestyle writer. When she’s not busy writing about her favorite money saving hacks or tinkering with her budget spreadsheets, she likes to travel, garden, and cook healthy vegetarian meals.
You might also check with your bank on your options to recast your mortgage. This option is not generally publicized, but after you make a bulk payment, the bank will “recast” your monthly payment to reflect the overall lower balance. The fee is usually nominal and you get the benefit of a lower payment.
We had a situation with an unexpected move, so we bought our house prior to selling our old one. After all the house was sold and transitional costs stabilized we made a six figure extra payment and the recast halved our monthly obligation. Our fixed expenses are now covered by one of our salaries, which helps if one of us would need to leave the workforce.