As the base rate reaches an unprecedented low of 1 per cent, millions of homeowners will be celebrating. More than four million households on tracker and variable-rate mortgages have enjoyed a £400-a-month drop in their repayments over the past three months.

Luckiest of all are the 1,500 borrowers who took out a two-year tracker from Cheltenham & Gloucester (C&G) in the summer of 2007. The deal, pegged at 1.01 percentage points below the base rate, gives them a current rate of minus 0.01 per cent. This means that not only are they paying no interest on their loan, but that C&G should, in theory, be paying interest to the customer.

C&G has already warned borrowers that it will not be paying back the money, claiming that there was a 0 per cent floor to the loan. Advisers say that such a stance could be subject to a legal challenge, but lenders are likely to defend their stance fiercely, especially if the base rate drops further. Other banks already lending for almost nothing include Birmingham Midshires, Halifax, Bradford & Bingley and Woolwich.

In the meantime, what should prudent borrowers do with the money they have saved?

Overpay the mortgage

This could reduce the mortgage term by years and save borrowers thousands of pounds in interest. For a borrower paying 3 per cent on a mortgage of £150,000 over 25 years, a £100-a-month overpayment would reduce the term by four years and save £11,842 in interest. Those overpaying by £400 a month would reduce the term by 11 years and save £30,181.

There are normally restrictions on the amount that a borrower can overpay. Most lenders allow up to 10 per cent a year without penalty, but this varies. Nationwide, for example, will let you overpay £500 a month, while Stroud & Swindon Building Society allows customers to clear 25 per cent of the outstanding loan each year.

Melanie Bien, of Savills Private Finance, the independent mortgage broker, says: “Most people are overpaying to reduce their loan-to-value ratio. With house prices continuing to fall, many homeowners will receive a shock when they come to remortgage and find that the cheapest deals are no longer available to them. Increasing the equity in your home will widen the choice of deals and enable you to access cheaper rates.”

Pay off debts

Those who are unable to overpay their mortgage should consider repaying other debts, such as credit cards, store cards and personal loans. Borrowers should prioritise their debts according to which have the highest interest rates and increase repayments on the most expensive debts first.

Diane Watson, of Payplan, the debt charity, says: “If you have some spare cash and are only repaying the minimum amount on your credit or store card, start making larger repayments. These cards can have interest rates of 20 per cent or more and the sooner you pay off the debt, the less interest you will pay in the long term.”

If a borrower had the average credit card balance of £1,384 at 17 per cent and paid only the minimum 2.5 per cent a month, there would be £1,331 in interest and it would take 17 years and 11 months to wipe out the debt. If the borrower paid £400 a month, there would be £24 in interest and the debt would be repaid within four months, according to Moneyfacts.co.uk, the financial website.

Although borrowers cannot usually increase the monthly repayment on a personal loan, it is possible to request an early settlement fee to pay off the loan in full.

If you have a student loan, remember that the Student Loans Company allows you to make as many overpayments as you wish without penalty.

Put it in savings

Savings returns have plummeted in recent months and the average rate on easy-access accounts now stands at 0.81 per cent. But as Britain enters a recession, savings should not be dismissed. Tom McPhail, of Hargreaves Lansdown, the independent financial adviser, says: “During these uncertain times everyone should have several months' worth of salary in the bank as an emergency fund in case you lose your job.”

Scarborough Building Society offers the best-buy rate of 3.5 per cent. If £400 a month is saved for 12 months at that rate, the saver would earn £72.94 in interest, equivalent to £58.36 after basic-rate tax.

Those who have not used their annual Isa allowance, which allows you to save up to £3,600 in cash each tax year without being taxed on the interest, can obtain a three-year fixed rate of 3.5 per cent with Nationwide Building Society.

Add to your pension

If you can afford to increase regular contributions to your pension, even a small amount can make a big difference to your income in retirement.

A 35-year-old who increased pension contributions by £400 a month over 30 years would accumulate an extra £240,000 by the age of 65, resulting in additional income of about £10,500 a year.

You and your employer can invest an amount equivalent to your annual salary each year and receive tax relief on contributions up to a maximum of £235,000. Workers can also take out a personal pension alongside a company scheme to pay in additional contributions.

Case study - Savings offset against loan

Donna Murray, 36, took out an Intelligent Finance two-year tracker mortgage in the summer of 2007. Her repayments have been reduced by £580 a month over the past year.

“My mortgage rate is pegged at a tenth of a point below base rate, so it has fallen dramatically and it is now only 0.9 per cent.

“Although I grabbed the deal in the summer, I did not complete until November 2007, so I still have almost a year left on the rate. I was really lucky to get the deal as it was just before the credit crunch started to unravel.”

Donna has two children and lives in a four-bedroom new-build house in West Lothian, Scotland.

She is keeping all her extra money in a savings account, which is offset against her mortgage. The interest on her savings is being used to overpay the home loan.

“I am saving for a rainy day at the moment,” she adds. “Rates will come back up at some point, so I need to be prepared for that.”