Should you Overpay on your mortgage?

Should you overpay on your mortgage? Overpaying on your mortgage can be beneficial, but there are a few things to consider before you commit. Let's break down the pros and cons of overpaying, so you can decide what's the right move for you.

Overpaying on your mortgage is typically available to most people, with the majority of mortgage lenders allowing overpayments of up to 10% per year without any penalty. 

Early Repayment Charges

It is important however to consider any Early Repayment Charges (ERC’s) that may be due. Most lenders will charge a 5% ERC, with the 5% being based on the amount you overpay (once you have exceeded your overpayment allowance). 

The ERC’s will also typically reduce the longer you are with the lender, although this is not guaranteed, as every lender has their own ERC structure. A typical ERC charge might be as follows:

ERC’s on a 5 year fixed rate:

• 5% - In the first year
• 4% - in the second year
• 3% - in the third year
• 2% - in the second year
• 1% - in the last year

ERC’S on a 2 year fixed rate:

• 2% - in the first year
• 1% - in the last year

The benefits of overpaying your Mortgage

So, the question of should I overpay is an important one, and with inflation reduced to 2% (Customer Price Index) at the time of writing, and cash savings offering lower interest rates than they were even a few months ago, it’s a question that a lot of people are asking.

Let’s start with the positives, then move on to the considerations, followed by our conclusion.  

There are many positives that come with making overpayments on your mortgage. These include, but are not limited to: 

• When you make an overpayment, the whole payment will be used to reduce your mortgage balance (excluding any fees charged by the lender). 
  
  This can be incredibly useful especially in the first few years where only a small portion of your monthly payment is used to reduce your mortgage balance, with the majority being used to cover the interest.  
   
• Even a small overpayment can have significant effects on your mortgage balance. For example, making an overpayment of just a £100 per month (around £3.33 per day) could reduce your mortgage balance by £30,000 over 25 years. This could increase to £60,000 if you make an overpayment of £200 per month. 
  
  Reducing your mortgage balance this way also has some added benefits, such as: 

§     You would typically stop paying interest straight away on the amount you have overpaid. 

With your monthly payments either reducing, or if your monthly payments stay the same, you will be making an overpayment each month by the amount you would have paid in interest, had you not made the overpayment.   

§     The ability to clear your mortgage sooner than expected – sometimes shaving a significant number of years off your mortgage term. 

§     Your Loan-To-Value (LTV) bracket could also reduce, resulting in a potentially lower interest rate when you come to remortgage, compared to what you would have been offered had you not made the overpayment. 

This is because the lenders typically categorise their products based on LTV with the higher LTV’s offering a higher interest rate, and the lower LTV’s offering a lower interest rate. 

However, lenders typically work on 5% intervals. For example, if your LTV is 91% you would potentially be offered a product that is up to 95% LTV despite being closer to the cheaper 90% LTV product. 

So, if you overpay by just 1%, you could reduce your LTV to 90% and be eligible for the cheaper product.  

§     Reducing your mortgage balance will result in lower monthly payments when you get to your remortgage date, when compared to what you would have been offered with a higher balance, as your mortgage balance will be lower.  

What to consider when overpaying on your mortgage

Whilst the above points may outline the positives of overpaying your mortgage, there are some important considerations to be aware of, including: 

• The main consideration currently is the comparison between interest on your mortgage when compared to interest rates being offered on other savings accounts. 
  
  For example, if you have £10,000 in spare cash, a mortgage charging you 2% interest, and an option to invest into a Tax-Free ISA offering 4% interest, it will potentially make more sense to invest the funds into the ISA instead of your mortgage. 
  
  This means you would effectively gain £200 (£10,000 x 2%, with 2% being the difference between the mortgage interest rate charged and an ISA interest rate, in this example). 
  
  When you also factor in that inflation erodes the real value of debt (mortgages) it can sometimes be more beneficial to invest your extra funds rather than making an overpayment on your mortgage. 
   
• Most lenders will usually charge an overpayment charge once you have exceeded your annual overpayment allowance (typically 10% of the outstanding balance). 
  
  These early repayment charges can sometimes be quite high, and typically vary from 1% - 5% of the amount repaid which can make overpayments slightly less cost efficient, and potentially making alternative investments more beneficial.
   
• Whilst overpayments can be beneficial, once the funds are used to reduce the mortgage balance, getting the funds back can be a time-consuming process which can sometimes involve costs and charges. 
  
  If you’re thinking over making overpayments but feel that you may need access to the funds soon, it may be better to reconsider overpaying.
   
• Do you have enough surplus funds in your savings? Generally, you should aim for at least 3 - 6 months’ worth of income to be kept within an easy access savings account in the case of emergencies. 
  
  Once you have sufficient savings, it might be time to consider overpaying on your mortgage. However, using all your savings to reduce your mortgage balance, leaving you without an emergency fund, could potentially leave you in a vulnerable position financially.
   
• If you have other debts with a higher interest rate than your mortgage, such as credit cards with no overpayment penalties, it may be more beneficial to clear those debts first before deciding to overpay on your mortgage or investing the money.  

How to know if overpaying on your mortgage is right for you

Overall, overpaying on your mortgage can be an easy way to accumulate wealth, reduce your mortgage term and reduce your monthly payments in a structured way. 

However, making an overpayment may be suitable if you meet the below criteria: 

• You do not need access to funds for the foreseeable future (excluding using the funds to buy a bigger house).
• You do not have any debts that are charging you a higher interest rate than your mortgage, without an overpayment charge.  
• You have an emergency fund.  
• Interest rates offered on savings accounts are lower than your current mortgage interest rate. 
• You are not intending to overpay by more than your annual overpayment allowance.  

It is always recommended that you speak to a mortgage professional as everyone's circumstances are different, and most mortgages will have different terms and conditions. 

So, even if you think that you would like to make an overpayment, it is always best to speak to a mortgage professional first to ensure that you’re not putting yourself at financial risk.

*This article does not constitute regulated financial advice. YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.