Should I Overpay My Mortgage?
12th June 2017
Overpaying your mortgage can reduce the total amount you pay for your home and help you become mortgage-free faster. However, not all mortgages allow overpayments. Before you overpay, it’s important to check whether your lender allows overpayments, as charges for doing so can be expensive. It’s also important to work out whether your mortgage rate is higher than your savings rate. Overpaying only makes financial sense if this is the case.
What are the benefits of overpaying my mortgage?
Overpaying your mortgage can be a sensible option if your mortgage allows overpayment. By overpaying, you’re reducing the amount you owe more quickly, helping you become mortgage-free faster.
Shortening your mortgage term by overpaying also means you’re reducing the amount of interest you pay. As a result, you’ll be spending less in the long run by paying more monthly.
Overpaying can make financial sense when interest rates are low, but only if your savings rate is lower than your mortgage rate. If you’re on a variable rate mortgage and interest rates were to rise, your monthly payments would rise too. You don’t pay interest on any overpayment, so by paying more when rates are low, you reduce the cost of the overall amount.
Overpayments don’t have to be hundreds of pounds a month - sometimes an extra £50 or £100 will make a difference to the saving you’ll make. This is because overpaying doesn’t just reduce the amount of debt you owe, but reduces your future interest payments.
In what circumstances should I overpay?
Before you decide to overpay, there are a few things you should consider.
Does your lender allow overpayments?
Not all mortgages allow overpayments, and some lenders charge hefty fees if you do overpay - it’s a deterrent because it’s in your lender’s interest to keep you once your initial rate finishes. As overpaying reduces the amount of interest you pay overall, your lender could lose out on the interest you’ll otherwise pay over the course of your mortgage deal.
If the money you’ll spend on fees is more than the amount you could save by overpaying, you’d save more by putting the cash in a savings account.
Some lenders allow up to 10% overpayment, but some have recently started allowing 20% overpayments on fixed rate deals. Make sure you check the terms of your mortgage even if overpayments are allowed, as often there’s a limit on the amount that can be overpaid.
Some lenders also charge a fee to close the mortgage account if you pay off the entire mortgage. This is dependant on the lender, but again it’s worth checking if this is the case before paying off the whole sum before the end of your mortgage term.
Do you have other debts to pay?
If you have debts that have a higher interest rate, it’s usually better to pay these off first. Interest rates on mortgages are usually much lower.
Do you have money saved for a rainy day?
Rather than using all your spare cash to overpay your mortgage, you should always have enough money to cover the costs of an emergency - such as redundancy or a broken boiler. Interest rates on mortgages compared to other loans are low, and you’d be better off keeping some money behind in case of emergency instead of taking out a high interest rate loan.
Lenders can still charge missed payment fees even if you’ve overpaid in the past, so it’s not advisable to overpay at the expense of losing a safety net of money for a rainy day.
Check your overpayments are reducing your mortgage, not just your interest
Overpaying just the interest on your mortgage won’t reduce the mortgage term. To reduce the term, you have to overpay the mortgage amount.
If you’re on an interest-only mortgage, you’ll need to talk to your lender about how to make overpaying worthwhile.
Check the interest on your savings
If you meet all the above criteria, don’t forget to check the interest on your savings before overpaying. If the interest on your savings (after tax) is higher than the interest on your mortgage rate, you’ll save more money by keeping the extra in savings.
Overpaying to get a better remortgage deal
At the moment, the best mortgage deals are available to those with more equity in their home - i.e. those who own more of their property outright.
You’ll own more of your home outright more quickly by overpaying, which could then give you access to lower rates when you come to remortgage.
Which kind of mortgage is best if I want to overpay?
Most fixed rate mortgages don’t allow overpayments. If they do, they often come with a fee. However, different types of mortgage can make overpaying an option.
Flexible mortgages are designed for people whose salary is likely to increase at times over the year - if you receive regular bonuses, for example. Flexible mortgages are attractive because they allow overpayments without charging a fee. Be aware that some flexible mortgages have higher interest rates than mortgages that don’t allow overpayments and so may not work out cheaper overall.
Some flexible mortgages also allow you to take the money you’ve overpaid out of your mortgage in financial emergencies.
Some tracker mortgages allow fee-free overpayments. If you think you’ll want to overpay, speak to a mortgage broker to find a deal that suits your circumstances. Some mortgage deals give you the option of paying up to 10% of your mortgage balance as an overpayment per year in your initial period. Every lender and deal is different, so always check before overpaying.
Fixed offset rate mortgages
With a fixed offset rate mortgage you can put in up to 100% of the mortgage balance into the offset savings account. If you had a mortgage balance of £100k, you could use any extra income to put the whole mortgage amount into the savings account, without paying interest.
Standard Variable Rate (SVR) mortgages
If you’re on your lender’s SVR, you can usually overpay as much as you like without a charge - one of an SVR’s few benefits. However, as we highlighted in our Mortgage Saver Review report, paying your lender’s SVR is often unnecessarily costly, and as a result, over 3 million UK homeowners are paying much more than they could if they switched to a more competitive deal. Before you decide to stay on the SVR, work out whether you’ll save more by staying and overpaying, or remortgaging to save money on a lower rate.