Key takeaways
- The Bank of England put the effective rate on the outstanding stock of UK mortgages at 3.96% in June 2026. Overpaying earns that rate, and nothing is taxed.
- Matching a 3.96% overpayment takes 4.95% gross from a savings account taxed at 20%, and 6.60% at 40%. Inside an ISA the hurdle stays 3.96%.
- The Bank's effective rate on new household time deposits was 4.30% in June 2026 — worth 3.44% after basic-rate tax and 2.58% after higher-rate tax.
- HSBC and Santander both cap penalty-free overpayments at 10% a year. Above it, HSBC charges 1% for each remaining year of the fixed period, to a 5% maximum.
- MSCI World returned 9.02% a year from 31 December 1987 to 31 July 2026, and fell 57.46% between October 2007 and March 2009.
A 3.96% overpayment is a 6.60% investment if you pay higher-rate tax
You've got spare money each month, a mortgage, and somewhere to invest it. The standard framing says to compare your mortgage rate with the return you expect from markets, then pick the bigger number. That comparison breaks in three separate places, and each break moves the answer.
Start with the rate itself. In June 2026 the Bank of England put the effective interest rate on the outstanding stock of UK mortgages at 3.96%. Every pound of balance you remove stops accruing interest at your own rate. Nobody taxes interest you never paid, so 3.96% is already a net number.
A return earned outside a tax wrapper isn't net. Gross 3.96% up for 40% Income Tax and you get 6.60%. At the 20% basic rate the hurdle is 4.95%, and at the 45% additional rate it's 7.20%. Those are the bars in the chart above, and they're what "compare the rates" should have meant all along.
Inside an ISA or a pension none of that applies, and the hurdle falls back to a bare 3.96%. Every tax figure here is for the 2026 to 2027 tax year in England, Wales and Northern Ireland, and Scotland's Income Tax bands differ.
The first mistake: a contractual 3.96% and a long-run average are different objects
Leave tax aside for a moment. The first problem is that the two sides of the comparison aren't the same kind of number at all.
The overpayment return is contractual. Reduce the balance, and the interest calculation follows at the rate written in your offer. There's no dispersion around it, no bad decade, no unlucky ordering of returns. It's the one return in personal finance you don't have to forecast.
The other side is a distribution. MSCI's factsheet for the MSCI World Index, dated 31 July 2026, puts the index's gross return at 9.02% a year since 31 December 1987. The same page reports a maximum drawdown of 57.46%, running from 31 October 2007 to 9 March 2009. Annualised standard deviation over the past 10 years was 14.85%. In calendar 2022 the index returned -17.73%.
MSCI prints the caveat on its own factsheet: "Past performance -- whether actual or back-tested -- is no indication or guarantee of future performance."
So 9.02% is the average of a path that included halving. 3.96% is a rate. If your fixed period has three years to run, the average isn't what you get — you get one draw from that distribution, and 2022 was one of the draws available.
One qualification, because it cuts the other way. The overpayment is only certain while your rate is. On a tracker or a variable rate, the return on an overpayment moves with the rate, and Bank Rate has been 3.75% since 18 December 2025 rather than forever. Certainty here means certain relative to your mortgage, not certain in the abstract.
The second mistake: the mortgage rate is already net and the investment return isn't
Now put the tax back in. Work it with the safest available comparison, a savings account, so the risk difference doesn't muddy the arithmetic.
In June 2026 the Bank of England put the effective interest rate on individuals' new time deposits at 4.30%. That's 0.34 percentage points above the 3.96% mortgage stock rate, and the usual framing stops right there, with the deposit ahead.
Tax the interest and it stops being ahead. A basic-rate taxpayer keeps 3.44% of that 4.30%. A higher-rate taxpayer keeps 2.58%. Against a 3.96% overpayment, that's a shortfall of 0.52 percentage points at basic rate and 1.38 percentage points at higher rate. The gross comparison and the net comparison give opposite answers, from the same two rates.
Capital gains work the same way with different numbers. Gains realised outside a wrapper are taxed at 18% within the basic Income Tax band and 24% above it, on disposals from 6 April 2026. Those lift the hurdle to 4.83% and 5.21%. Lower than the interest hurdles, because the rates are lower — and still above 3.96%.
Our guide to UK investment tax rates and allowances carries the full 2026 to 2027 table, dividends included. The point here is narrower. Any return taxed on the way through has to clear the mortgage rate after tax, not before it, and the gap between those two things widens with your marginal rate.
Where the tax argument reverses: the first £1,000 of interest is free
The allowances flip this for smaller balances, and that's what the "compare the rates" framing misses in the other direction.
The Personal Savings Allowance is £1,000 for a basic-rate taxpayer, £500 for a higher-rate taxpayer, and nothing at the additional rate. At 4.30%, generating £1,000 of interest takes roughly £23,256 of deposits. Generating £500 takes roughly £11,628. Below those balances the interest isn't taxed at all, the hurdle is the headline rate, and 4.30% beats 3.96% cleanly.
There's a second allowance underneath it for people with low other income. GOV.UK puts it plainly: "You may also get up to £5,000 of interest and not have to pay tax on it. This is your starting rate for savings." It tapers away and is gone once your other income reaches £17,570.
Wrappers do the same job with no ceiling on the return. The ISA subscription limit is £20,000 for 2026 to 2027, interest and gains inside it aren't taxed, and the hurdle sits at the bare 3.96%. There's a £3,000 annual exempt amount for capital gains outside a wrapper too, which does the same job for a smaller portfolio. Which assets belong in which account is the subject of asset location, and it does more work in this decision than the choice of asset does.
The third mistake: the 10% cap binds before the arithmetic does
The third break is contractual rather than mathematical. Even where the numbers favour overpaying, most fixed-rate borrowers can't act on it at any scale.
Santander's terms are representative: "Overpay up to 10% of any fixed rate loan each calendar year (January to December) without paying an early repayment charge." Unused allowance doesn't carry forward. HSBC sets the same 10% of the outstanding balance, measured annually from the date the fixed rate started.
Above the allowance, HSBC's charge "is calculated as 1% of the amount repaid early, above any annual overpayment allowance, for each remaining year of the period during which the ERC applies, reducing on a daily basis", subject to "a maximum 5% of your overpayment".
Put numbers on that. Take a £200,000 balance on a five-year fix with four years still to run. The penalty-free allowance is £20,000. Overpay £30,000 in one year and £10,000 sits above the allowance, charged at 4% — that's £400.
The first year of interest saved on that £10,000 at 3.96% is £396. So the charge eats roughly the whole first year of the benefit, and the overpayment only starts working in year two. Whether that's worth it depends on how long the money would otherwise stay put. What matters is that the gross rate comparison never sees this cost at all.
The constraint disappears outside a fixed period. HSBC on trackers: "There's no early repayment charge, so you can make unlimited overpayments." Santander says the same for anyone not on a fixed rate. The regulator sets an outer limit rather than a level: MCOB 12.3.1R requires that any early repayment charge be "able to be expressed as a cash value" and "a reasonable pre-estimate of the costs as a result of the customer repaying the amount due under the regulated mortgage contract before the contract has terminated".
Money in the mortgage comes back only as a new loan
The asymmetry is the part people notice last and regret first. Money you put into a fund can come out of it. Money you put into a mortgage balance can't, in the ordinary sense of the word.
Getting it back means borrowing it again, and that's a regulated transaction with a test attached. MCOB 11.6.2R requires a firm to assess whether the customer "will be able to pay the sums due" before entering into or varying a regulated mortgage contract, and provides that "the firm must not enter into the transaction in (a) unless it can demonstrate that the new or varied regulated mortgage contract or home purchase plan is affordable for the customer (and any guarantor)".
So an overpaid pound comes back only if a lender agrees, at whatever rate exists then, against whatever income you have then. Redundancy, a business going quiet, a health event: the moments you'd most want the money are the moments an affordability assessment goes worst. The equity is real, and it's still in the house.
A withdrawal from an ISA needs nobody's permission by contrast, though the ISA rules have their own catch on what a withdrawal costs your allowance, set out in the ISA rules that bite. That difference isn't a rate, so it never appears in the rate comparison. It's usually the thing people wish they'd priced.
The strongest case against overpaying
Here's the objection that survives all three points above, and it's a serious one.
Put the money inside a wrapper and the tax argument vanishes completely. The hurdle is 3.96%, and MSCI World's 9.02% a year since 1987 clears it by a wide margin. Over 20 or 30 years, on that history, the wrapper wins comfortably and often by a lot. Anyone treating the tax point as decisive has quietly assumed a taxable account.
Two further points cut the same way. The 3.96% figure is an average across every outstanding UK mortgage, and yours may sit well below it. The rate on newly drawn mortgages was 4.35% in June 2026, above the stock rate, because older fixes are cheaper than today's pricing. Sitting on a legacy fix means a much lower hurdle and a much stronger case for investing. And an employer pension match, covered in our ISA versus pension arithmetic, can dwarf both sides of this comparison before a single market return is earned.
Refereeing it honestly: the counter-case is strong over long horizons and weak over short ones. A five-year fixed period is one draw, not an average, and the worst realised draw in this data was a 57.46% fall. The counter-case wins on expectation. The overpayment wins on certainty. Those are different questions, and no arithmetic ranks them for you.
What this arithmetic cannot tell you
Several things, and each of them can move the answer more than the tax adjustment does.
The Bank of England figures are averages across the whole market. Your mortgage rate is the one in your offer, and the entire calculation reruns with it. The same goes for the deposit side: 4.30% was the effective rate on new time deposits in June 2026, not a rate you're necessarily offered.
The MSCI World numbers are gross returns in US dollars across 23 developed markets. They carry no fund charges, no dealing costs and no withholding tax, and a sterling investor's outcome also depends on the currency. The 9.02% is one sample of market history, not a forecast, and MSCI says so itself.
The early repayment terms quoted are HSBC's and Santander's, not the market's. MCOB 12.3.1R requires only a reasonable pre-estimate of the lender's costs, so the level differs between lenders and between products. Yours is in your offer document.
And the comparison assumes the money is genuinely spare. Cash held against an emergency isn't in this trade at all, on either side.
What would change the answer
A different mortgage rate. At the 4.35% rate on new lending, the higher-rate hurdle rises to 7.25%. On an old fix well below 3.96%, it collapses. The hurdle is your rate, grossed up for your marginal tax band, and nothing else.
A move in Bank Rate. It's been 3.75% since December 2025. Deposit and mortgage rates both follow it, at different speeds — the stock rate lags by years, because fixed deals roll off slowly.
A change to the allowances. If the £1,000 Personal Savings Allowance moved, or the £20,000 ISA limit did, the reversal point in the middle of this piece moves with them.
Coming off a fix. On a tracker or a variable rate the 10% cap and the charge both disappear, and the constraint stops binding at all.
The number worth watching isn't the market's. It's the gap between the rate in your mortgage offer and what you actually keep, after tax, from the alternative. LedgerTouch tracks the second half of that; your lender's annual statement has the first.