Some fortunate borrowers who are now paying 1 per cent or less on their mortgages could be better off saving their rate-cut windfalls rather than following conventional wisdom to pay down debt with the spare cash.
More than a million homeowners have seen monthly mortgage costs reduce by hundreds of pounds since last autumn as the Bank of England has slashed the base rate to record lows. This week the base rate dropped another half-point to 1.5 per cent.
Experts say that, in many cases, the best use for these surplus monies could be to overpay mortgages – particularly at a time of job insecurity.
But for borrowers paying close to or even less than the base rate, there is the opportunity to earn a guaranteed profit over the cost of their loan.
While savings rates have also dived, it is still possible to lock in to fixed-rate bonds paying up to 5 per cent – worth 3 per cent after tax to a higher-rate taxpayer.
Saving, rather than repaying, could therefore give 2 percentage points of extra return for a borrower with a mortgage costing 1 per cent.
This “arbitrage” could be worth more if mortgage rates fell further or if the savings were held in the name of a non-taxpaying spouse.
It might even make sense for some borrowers to draw down previous repayments or seek a mortgage payment holiday to add to the benefit. In some cases, the arbitrage could yield thousands of pounds of profit over the coming year.
Adrian Lowcock, senior investment adviser at Bestinvest, said: “It’s not the conventional wisdom and typically advisers wouldn’t recommend it. But it’s an opportunity for people with a level of security in their financial situation.”
Borrowers now paying 1 per cent on their mortgages typically took out below-base rate tracker loans that were widely available more than a year ago.
Lenders allowing customers to borrow back overpayments at existing low rates include Nationwide Building Society and Co-operative Bank, according to mortgage experts, while many flexible loans allow payment holidays. However, some lenders may levy additional costs for increasing borrowings.
With most below-base rate deals coming to an end this year, Lowcock said short-term savings bonds were a low-risk way of playing this arbitrage.
When the bond matures, the cash can be used to pay down the mortgage. “It’s critical if you are going to do this to have money available to be able to pay down your loan (when rates rise again),” he said.
Investing this cheap cash, particularly in a pension, could also be attractive to some low-rate borrowers. As well as being able to buy into markets at relatively low levels, higher rate taxpayers benefit from 40 per cent tax relief on their pension investments.
However, in this case borrowers would face the risk of losing money and, with a pension, would not be able to access the cash until retirement.
Tom McPhail of Hargreaves Lansdown financial advisers said: “You need to slap a big fat risk warning on this [idea].”
However, investing cheap money now could look like a canny move in a few years’ time, particularly if inflation were to pick up again, reducing the real cost of debts.
Experts add that with employment prospects so uncertain, even borrowers with higher-cost mortgages should consider putting spare cash from rate cuts into an easy access account, rather than paying down their loans.
“If you’re more concerned about cashflow, build up your ‘rainy day’ funds,” said Lowcock.
