If you are considering overpaying on your mortgage, you will be looking to reduce how much interest you pay and bring forward the day you are mortgage-free.
But before going ahead with this apparent no-brainer, it’s important to be sure that it’s the best use of the funds available for you. You will also want to avoid being charged fees for going over your lender’s limit. So here are the pitfalls and positives of mortgage overpayment.
What is a mortgage overpayment?
When you overpay on your mortgage, you voluntarily pay more than the minimum monthly repayment amount set by your lender. What you can and cannot do varies across deals and lenders, so check any restrictions in your agreement before going ahead with overpayments. You may have the option of overpaying with a one-off or occasional lump sum, or with regular payments on top of your monthly payment.
Why make mortgage overpayments?
It is a good question, especially if your mortgage payments are your biggest regular outgoing. But if you have the extra funds to hand, mortgage overpayments can be a way to clear your debt sooner, while saving money in interest.
Here is how that could work in your favour:
- You could be mortgage-free sooner. As you will pay off more of the money you originally borrowed quicker than you first calculated, you could pay off your mortgage ahead of time.
- You could reduce how much interest you pay overall. By shortening how long it takes to pay off your mortgage, you will pay less total interest over the lifetime of the mortgage.
- You will be charged interest on a lower amount. Your monthly interest rate is calculated on the outstanding sum of the loan. As what you owe reduces over time through overpayments and your regular repayments, the interest part of your mortgage repayments will be calculated on a smaller amount.
- Your house equity could increase sooner. If you pay off more of the capital quicker, your loan-to-value (LTV) ratio will reduce. This could give you access to more competitive mortgage rates if you remortgage to another deal later.
- It can offer you more flexibility. If it is an option, you may be able to make overpayments as and when you want to or regularly, especially if you manage your mortgage online or through an app. This can let you overpay in a way that suits you, or not at all when it does not. It is worth remembering that typically providers only allow you to overpay by 10% each year before charging you fees.
How much can you save by overpaying your mortgage?
Overpayments could help save borrowers thousands of pounds in interest over the lifetime of a mortgage. How much you might save depends on a few variables, such as how much you are looking to overpay and the interest rate of your deal.
The example below is an estimate of how much money overpayments could save a borrower over time.
Say you owe £250,000 on your mortgage and are paying an interest rate of 3.5%, with 20 years left of your mortgage term. Assuming your interest rate stays the same and you keep within your lender’s overpayment limits:
- An extra £50 as a regular monthly overpaying would save you £5,088 in interest alone, and mean you pay the mortgage debt off in full 11 months earlier.
- An extra £200 as a regular monthly overpaying would save you £17,533 in interest, and you would pay the debt off in full 3 years & 3 months earlier.
- Making a lump sum one-off overpayment of £20,000 would save you £18,659 in interest, and mean you will pay the debt off in full 2 years & 2 months earlier.
When you might consider making mortgage overpayments
You may be looking to pay off a large chunk of your mortgage after inheriting money or selling an asset. Or you could want to increase your monthly repayments because you have had a pay rise or a bonus, or are making savings elsewhere, perhaps through securing a lower mortgage interest rate.
When it comes to making the overpayments, timing is important. If your mortgage provider allows overpayments, find out when the interest on your loan is calculated. If it is daily or weekly, you could make overpayments whenever you like without bothering too much about timing.
But if interest is calculated monthly or quarterly, you might want to be more strategic. You could aim to make your overpayments just before your interest is calculated. This may save you money because it will be calculated on a lower loan amount. It is always worth checking how it works with your lender directly before making any decisions on when to overpay.
There are some important things to bear in mind before taking the overpayment route.
Check your lender’s overpayment restrictions
Not all lenders allow overpayments. But if yours does, it may have an overpayment limit in place. This is usually no more than 10% of the total outstanding debt each year, but your mortgage agreement will confirm the amount. Go above the overpayment limit and you will have to pay an early repayment charge (ERC).
Some mortgage deals, such as tracker and standard variable rate mortgages, let you overpay as much as you like without a penalty
Consider paying off other debts first
If you have other debts, such as credit cards or other loans, make sure that making overpayments will not mean you take longer to clear these. This is especially the case if they charge a high rate of interest.
Make sure you can afford to make overpayments
If you are not confident that regular monthly overpayments would be sustainable, the flexibility of making occasional lump sum payments might be a better option. If either method would stretch your finances too far, you may be better off sticking with your original mortgage payment plan.
Be clear about what you want overpayments to achieve
Before you make overpayments, tell your lender what your goal is. For example, if you are looking to shorten your mortgage term, you will want to ask that it keeps your regular monthly payments the same, so you are overpaying.
Otherwise, your lender may reduce your monthly payments in line with the reduced loan amount and your mortgage term will stay the same. Bear in mind that your lender’s terms and how much you are looking to overpay might affect what options are open to you.
So, should you overpay on your mortgage?
Overpaying is not the answer for everyone. While there are obvious advantages to getting your mortgage loan cleared as fast as possible when you have extra money to hand, it needs to be affordable and right for your financial circumstances. Talk to your lender to see how overpaying on your mortgage could help you too.