I am in the lucky position of having a 2% fixed rate mortgage. Intend to save up and pay this off before it ends and becomes a variable interest.
I am saving in a 4% interest bank account. I am assuming this is better than overpaying the mortgage - however there is a niggling doubt that mortgage interest is compounded daily?
Yes, you're right that it will be better, but don't forget that you may pay tax on some of the interest you earn depending on your personal situation. But even if you pay the highest rate (and you probably wouldn't be asking here if you were in that bracket) you'd still be slightly better off with the savings.
Mortgage interest is normally calculated daily and compounded monthly (which is why your statement will show a lower amount for February) but as rogerzilla says the rate is the annual equivalent.
You can do better than 4% at the moment, particularly as you don't need instant access. Eg Nationwide just sent an email about their 8% regular saver (max £200 a month for a year) these sorts of accounts come up regularly but last a year at a time. Then at the end of the year stick it in a fixed term bond - you can't get the money out or pay any more in until the end of the term, but neither could you easily if you'd overpaid the mortgage instead. Rates are currently around 6.2% for 1 year and 5.8% for two years.
Given you know exactly when you need the money, these bonds are perfect. Bank rates will go down, so it's important to get a fixed rate out to approximately the end of your mortgage fix at a higher rate than the mortgage. If your savings are in a variable rate account that goes below that (after tax) you can't at that point just bung it in the mortgage, you'll be limited to 10% of the outstanding.
Oh and don't pay the mortgage off just before it goes variable, pay it just after, otherwise you'll be hit with an early repayment penalty.
