House Doctor: 'Should we use our life savings to pay down our mortgage debt?'

Question: Our five-year fixed-rate mortgage of £135,000 has a 5.4 per cent rate with Halifax while we're earning barely 1.5 per cent on roughly £18,000 savings with a rival bank. Should we pay down the home loan, which has 15 years left, with as much of our savings as we can? My husband says it's a mistake to tap into our emergency cash just to reduce our mortgage interest but I think we're hurling money down the drain by carrying on as we are.

Rhona Costen, Salford

Answer: General dismay at low savings rates – an average of 0.74 per cent on a no-notice savings account, according to the Fair Investment Company – has prompted many savers to weigh up an alternative use for their cash in the bank.

And while using up hard-earned savings to pay down mortgage debt will feel like taking a risky step backwards, not paying down some of your savings is costing you and your husband money.

Here's how: imagine a £30,000 mortgage debt at your 5.4 per cent and the same sum in savings – a very comfortable cushion for many – earning 1.5 per cent. The annual interest cost of the home loan is £1,620 while the savings earn a paltry £450, so pay off the mortgage with the savings and you'd instantly be £1,170 better off.

So, if your mortgage rate is greater than your after-tax savings interest, it won't be worth saving – overpay the mortgage instead. Alternatively, think of it this way: paying off part of your mortgage is a form of saving. To earn that £1,170 a year, after tax, on £30,000 in an easy-access savings account, a basic-rate taxpayer would need an interest rate of 4.88 per cent, and a higher-rate taxpayer 6.5 per cent.

These kinds of savings rates, once commonplace, no longer exist. So in a climate where the Bank of England base rate has spent a year and a half at 0.5 per cent, overpaying your mortgage debt makes sense.

In your case, the Halifax mortgage debt currently has an annual interest cost of £7,290 a year. At the same time, your savings are earning a paltry annual £270 – so it's currently costing you £7,020 a year simply to keep your savings in place.

Say you overpay £10,000 from your savings: this would knock £4,612 off the overall interest bill of your mortgage, as well as leaving you with a sizeable savings pot for emergencies.

By contrast, if you kept the same £10,000 saved, assuming it stays at an average interest rate of 1.5 per cent over the same time, it would earn you roughly £1,959 – less than half the benefit.

"If you'd prefer flexibility, you could consider switching to an offset mortgage," says David Black at financial analyst Defaqto. "It lets you forgo interest on your savings in return for not paying interest on a portion of your mortgage."