Is it better to overpay your mortgage or pay into your pension?

At a glance

• Overpaying your mortgage could help you save serious amounts in interest and potentially mean you’re debt-free sooner.
• Topping up your pension could lead to significant investment growth over the years (but there’s no guarantee).
• Saving could be another option for more flexibility, but may not be as beneficial over time.

Earning a little extra money each month, whether by getting a pay rise or paying off a long-term debt, can be a great boost to your personal finances. But what should you do with the extra cash? Although it can be tempting to spend it, it may be worth thinking more long-term, and considering how this can help secure your future instead.

Overpaying your mortgage and topping up your pension are both great options to consider, but which is better? This guide will cover everything you need to think about to help you make the right decision for your needs.

Benefits of overpaying your mortgage

Overpaying your mortgage can have numerous financial benefits. The first is that overpaying will reduce your mortgage balance, which in turn will cut the amount of interest you pay, saving you money over the long-term. This could also mean you’re able to reduce your overall mortgage term to pay your mortgage off early and essentially become debt-free sooner.

Another potential benefit is that by reducing your mortgage balance, you’re also lowering your loan-to-value (LTV), which could mean you’re able to get a cheaper deal when it’s time to remortgage. This could save you money on a monthly basis as well. You can use our mortgage repayment calculator to see what your potential repayments could be and work out your savings.

Should you overpay your mortgage?

The benefits of overpaying your mortgage are one thing, but knowing whether you actually should overpay is another, as it’ll all depend on your mortgage deal and your own financial situation. You’ll need to consider things like:

• Whether your mortgage deal allows overpayments. Most fixed term mortgage deals allow overpayments of up to 10% each year without applying any early repayment charges (ERC), so you’ll need to plan your overpayments carefully. If you incur any ERCs, you may not save as much as you were hoping. Variable rate deals can be more flexible, but unless you’re on an SVR there may still be limits in place.
• Early repayment charges. If you overpay too much, early repayment charges could kick in and could outweigh any potential saving.
• The remaining term on the mortgage. This can be particularly important if you’re likely to still be making repayments into your retirement years. In this case, you may want to prioritise overpayments to clear the debt beforehand.
• Your income/financial situation. If you’ve got sufficient savings elsewhere that can be called upon in an emergency, overpaying your mortgage could be worth considering. If not, or if you were struggling before the boost in monthly income, it may be preferable to use the additional cash to save or boost your daily living standards.
• The amount you want to overpay. Overpaying your mortgage can be ideal if you’ve got a small additional amount each month that you want to put to good use, and crucially, you can afford to do without it on a day-to-day basis. If you’ve got a bigger lump sum to invest – such as an inheritance – overpaying may not be suitable due to ERC restrictions.

Benefits of increasing your pension contributions

One of the key benefits of increasing your pension contributions is the potential for investment growth. Over time, investments could grow far more in value than the amount you could save in mortgage interest, which could leave you far better off in retirement. The downside is that growth is not guaranteed, and past performance is never an indicator of future returns.

Yet there are other benefits to consider when it comes to increasing your pension contributions as well. These include:

Tax efficiency

One of the main benefits of making pension contributions is that it benefits from tax relief. This is a significant point to consider, as saving more can enhance your pension.

The tax relief paid on pension contributions in England, Wales and Northern Ireland depends on your rate of income tax. In essence, it breaks down to:

It’s worth noting everyone will get a 20% pension tax relief automatically added to their pot, but higher and additional-rate taxpayers must complete a self-assessment return for the extra.

Just make sure to bear in mind the annual allowance. Pension contributions of up to £60,000 (or 100% of your level of earnings if lower) are eligible for tax relief, with anything else contributed to your pot during the tax-year liable for income tax. If you’ve already exceeded this allowance, then it may be worth paying off your mortgage instead.

Employer top-ups

Another benefit is that many employers will increase their contribution in line with your own. This is often known as contribution matching and could result in a significant addition to your pension pot, though bear in mind that they may only increase it up to a certain limit, and not all employers will offer this benefit.

Salary sacrifice

If you want a pay rise to directly benefit your pension pot, you may want to consider salary sacrifice, where a portion of your gross salary is automatically funnelled into your workplace pension instead. This not only means you’re making higher pension contributions but, because your gross salary is lower, could result in lower National Insurance and Income Tax payments as well.

This perk could be particularly beneficial for higher earners, where a pay rise could result in a higher tax bracket; by taking the option of salary sacrifice, their additional pay goes towards their retirement savings instead, and they won’t have to pay additional tax.

How to decide whether to overpay your mortgage or pension

So should you overpay your mortgage or invest in a pension? It’s a personal decision and there’s no one-size-fits-all answer, so here are a few things you should consider:

Your mortgage rate

If your mortgage rate is high, it may be worth overpaying to reduce your mortgage balance and therefore also the amount of interest you’re having to pay on it. This could not only benefit you in the long-term, but also in the short-term, as it could lead to lower repayments when it’s time to remortgage.

Conversely, if your mortgage rate is low, it may be more beneficial to contribute more to your pension pot, as the investment returns could potentially be much higher than the savings you’d make in mortgage interest.

Your age and retirement plans

Another factor to consider is your age and when your pension contributions started. Those who started a pension early in their career, for example in their early to mid-20s, will likely find that they can contribute less each month and still enjoy a comparable retirement to those who started a pension later in their career.

As such, those who began a pension in their 30s/40s or who are already approaching retirement age may want to consider increasing their pension contributions, helping them enjoy a more comfortable retirement without having to work past the state pension age.

Taxpayer status

Higher and additional rate taxpayers in particular may want to consider increasing their pension contributions instead of making mortgage overpayments, as it could bring down their taxable income to reduce the amount of income tax they pay while potentially helping them benefit from investment returns over time.

Overpay mortgage or invest – why not do both?

Instead of needing to pick one or the other, there’s nothing stopping you from doing both – if you’ve got a big enough income boost you could overpay your mortgage balance by 10% AND put anything extra into your pension pot, giving you the best of both worlds. Just make sure that you’ve got suitable savings elsewhere, and that you’re not going to struggle financially by diverting all of your extra income into inaccessible investments.

How a financial adviser could help

Ultimately, whether it’s better to overpay a mortgage or pay into a pension all comes down to your circumstances. So, if you’re considering whether to increase your mortgage repayments or your pension contributions, we encourage you to speak to an independent financial adviser who will be able to discuss all the options available. This will include considering the impact of tax on your decision and suggesting options that are right for your individual financial circumstances.

Those with a minimum of £100,000 in savings and investments can book a one-hour free consultation with independent financial advisers Kellands. The free consultation can be booked online here.

Should you save instead?

Not sure if you should pay off a mortgage or pay into a pension? Well, why not save instead? This could be a great option for those who want more flexibility from their excess cash as you’ll be able to access it should you need to (notwithstanding any fixed rate periods), unlike with mortgage overpayments or pension contributions. Plus, if you opted for an ISA, you could still benefit from tax efficiency.

The downside of saving in cash is that the potential returns will likely be far less than that which could be achieved by the investment growth of a pension, and you may not earn enough in savings interest to outweigh the amount that could have been saved in mortgage interest. Though this will always be determined by the rates on offer, and it’s worth speaking with a financial adviser to help determine the best option for your needs.

Find the best savings rates

If you’re considering saving instead, you need to make sure you’re getting the best rate possible. Our savings and ISA charts are regularly updated to highlight the best savings rates currently available.