Overpaying can reduce the time it takes for you to repay your mortgage and also means you will be charged less in interest
WE LOOK AT THE ADVANTAGES AND DISADVANTAGES OF MAKING MORTGAGE OVERPAYMENTS
Depending on the type of mortgage you have the mortgage balance may or may not change during the course of each year. With an interest only loan the balance will not change but with a repayment mortgage each monthly payments will cause the debt to reduce.
If your introductory deal has finished and you are paying your lender’s standard variable rate (SVR), you can usually overpay your mortgage by as much as you want.
Most lenders allow you to pay 10% of your mortgage balance as an overpayment per year even if you’re still in your introductory fixed, tracker or discount period.
However, the 10% rule is not universal.
But there are also downsides to be aware of.
Some lenders may penalise those who try to overpay with an Early Repayment Charge or ERC. The amount you pay as a penalty will vary between mortgage deals.
WHY SHOULD YOU OVERPAY YOUR MORTGAGE?
There are several great reasons to make overpayments:
TO REPAY THE MORTGAGE SOONER
The faster you can repay the amount you borrowed, the sooner you’ll be debt-free. Many people dream of being mortgage-free and living without the burden of the monthly repayments.
TO PAY LESS INTEREST
Because interest accumulates over time, the total you pay in interest increases the longer you have the loan. So, repaying more quickly also reduces the total amount you repay, in most situations.
TO MAKE THE BEST USE OF YOUR MONEY
Interest rates are currently very low, meaning that most savings accounts may offer very little growth. If you have spare money, or have just received a windfall, you may be looking for a smarter way to use that money. Some of your options are: shopping around for a better interest rate, making a lump sum contribution to your pension, or making an overpayment on your mortgage.
WHEN SHOULD YOU NOT OVERPAY YOUR MORTGAGE?
There are a number of reasons to think twice before making overpayments:
WHILE YOU’RE IN AN INTRODUCTORY PERIOD
Often, mortgage providers will charge you a penalty for making overpayments while you’re in the introductory period of your mortgage (for example, a two-year fixed rate). So, it’s less certain that you’ll benefit financially from making an overpayment, and you’ll need to check and make some calculations first.
IF YOU’VE ALREADY MADE OVERPAYMENTS THIS YEAR
Usually, mortgage providers will have a cap on how much you can overpay in a year. Making overpayments above this amount can result in financial penalties or ERC’s, potentially costing you thousands of pounds.
WHEN YOU HAVE HIGHER PRIORITY DEBTS
Your mortgage repayments are likely to be among your highest monthly outgoings, but you may have other, higher interest debts to service. When you are considering which to pay off first, this is a more important factor. So, if you have high interest credit cards and unsecured debts look at reducing those before making mortgage overpayments.
IF YOU DON’T HAVE ENOUGH SAVINGS
While your cash savings may not be growing much right now, it is still important to have some cash set aside for emergencies, especially as we’re living in unpredictable times. So, if your total savings would cover less than three to six months’ worth of living costs, it might be more sensible to hold onto them rather than overpay.
HOW DO YOU MAKE MORTGAGE OVERPAYMENTS?
Check first with your mortgage provider to see how much you can overpay without additional fees.
Most lenders have an annual limit of 10% of the remaining balance, but yours could be more or less than that. You’ll also want to check how your interest is calculated, so you can make your overpayment at the right time.
Sometimes your mortgage interest is calculated daily, in which case you’ll want to make the overpayment as soon as possible, for maximum benefit. In other cases, the interest is calculated monthly or annually. Usually, you can choose whether to make a lump-sum overpayment (best if you’ve had a windfall) or to pay a little more some months (best if you have extra money from overtime or commission).
When you make extra mortgage payments you need to decide what happens to your future monthly payments. As your mortgage will reduce more quickly, your payments need adjusting as the mortgage balance is lower than planned for when you first applied. So, you can choose to have a lower mortgage payment, and keep the same mortgage term, or keep the mortgage payment the same and pay the mortgage off sooner than planned.
Speak to your mortgage lender to confirm what options exist.
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Sean Horton is a co-owner of Drake Mortgages and has worked in financial services, mortgages and insurance since 1988. Previously a financial adviser and a mortgage broker, he regularly writes about mortgages, bridging loans and commercial finance.
