Making a good return

Mortgage overpayments are a good deal when the best deposit rates fall short of inflation, writes Laura Slattery

Now that all Special Savings Incentive Accounts (SSIAs) have finally matured, avid interest rate watchers will be on permanent lookout for the best deal that doesn't involve jeopardising a cent of their steadily accrued cash.

But one maxim commonly applied to personal finances is that it makes little sense to keep a substantial stash of money tucked away in a deposit account, when you've got a variety of debts on which you are being charged higher rates of interest.

According to figures from SSIA provider Irish Life, around €1.1 billion of the €16 billion that has flowed from matured SSIA funds will be used to eliminate debt.

Much of this €1.1 billion will be used to pay off pesky car loans and stubborn credit card debts that consumers have built up over the five years in which they were also contributing to their SSIA.

With the unprecedented good value of the State's €1-for-every-€4 offer - a 25 per cent bonus - it made sense for consumers to throw as much money as they could into their SSIAs, even if it also meant they had to resort to short-term loans in order to plug the gaps in their finances.

With SSIAs gone, the best savings offers around are a little more modest. The highest rate available on regular savings is currently 7.1 per cent from AIB. For lump sum deposits the best interest rate on demand is 5 per cent from RaboDirect. This rate applies to the first €10,000, with the online bank giving a rate of 3.75 per cent on additional savings.

But after a succession of seven hikes in the European Central Bank (ECB) base interest rate, many homeowners either already are or soon will be paying even higher interest rates on their mortgages.

A typical tracker mortgage interest rate charged to first-time buyers is the ECB rate plus a percentage point margin of 1.1. So when the ECB rate was at its historic low of 2 per cent, borrowers were paying 3.1 per cent. Now that the ECB rate has climbed to 3.75 per cent, these borrowers are paying a rate of 4.85 per cent on their loans.

The ECB is now expected to raise interest rates by a further quarter point in June, taking typical tracker mortgage rates up to 5.1 per cent - higher than the best deposit rates currently available.

Using a lump sum to pay down mortgage debt can yield astonishing savings, even for more established homeowners who qualify for lower mortgage rates.

For example, a borrower with €200,000 outstanding on a mortgage and a remaining term of 28 years could cut €52,400 off the total mortgage interest bill if he or she uses a €20,000 lump sum to pay down the mortgage.

Based on an interest rate of 5.1 per cent, the mortgage term will also be shortened by five years and four months.

Alternatively, the borrower could decide to keep the term of the mortgage the same and benefit instead from lower monthly repayments.

Not every former SSIA holder wants to be boring and sensible with their lump sums. But even if plans for extensive home improvements, a flashy new car or a budget-free holiday are set in concrete, there is still the question of what 1.1 million people will do with the monthly money they used to divert into their SSIAs.

So far evidence from financial institutions suggests that many people continue to save regularly even after they have been freed from their SSIA. According to Bank of Ireland, 62 per cent of its customers are doing so.

But if the borrower in the previous example was to arrange to overpay his or her mortgage by €254 a month - the maximum contribution allowed under the SSIA scheme - he or she would cut their total interest bill by €64,000 and pay off the loan a whopping nine years earlier.

If the borrower makes both a lump sum overpayment of €20,000 and regular overpayments of €254 a month, the mortgage term will shrink by a potentially life-altering 12 years and the total interest - assuming rates stay the same - would be €92,600 less.

That's hardly a bad return, especially considering the best deposit rates are currently falling short of inflation rates, meaning the real value of the money is being eroded. But before SSIA holders turn over their entire lump sums to their mortgage lenders, they should make sure they have an easily accessible savings fund of at least three or four months' salary set aside in case of emergencies.

At most lenders, once a lump sum is used to pay down the mortgage, an inordinate amount of paperwork will be required to undo the action. The least flexible lenders will classify any dipping into the mortgage as a top-up loan and charge the corresponding legal fees, while borrowers on fixed rates will be charged penalties for overpaying.

Offset mortgages are the most flexible type of mortgage for people with lump sums. Available from First Active and National Irish Bank, they are specifically designed to help people with large cash balances save interest on their mortgage.

Borrowers don't have to make formal lump sum overpayments in order to cut their interest bill. Instead the value of any cash resting in their current and savings accounts is subtracted from the outstanding mortgage, so that interest is only charged on the balance.

Up to now, offset mortgages have been a niche offering, but with plenty of SSIA holders with more money than spending ideas, they could be a good option for someone whose next personal finance target is to obliterate their mortgage.