Should You Overpay Your Mortgage Monthly or Make a Lump Sum Payment?

Overpaying your mortgage can help reduce the interest you pay and potentially help you clear your mortgage sooner, reducing the total cost of borrowing. This can be done through regular monthly overpayments, occasional lump sums or a combination of both.

But should you overpay your mortgage or keep the money safe for a rainy day? Before deciding, it is important to understand how mortgage interest rates work and whether or not your mortgage has any overpayment limits or early repayment charges (ERCs).

In this article, we cover exactly how mortgage overpayments work, whether it is better to overpay mortgage monthly or lump sum and whether saving your spare money could be a better option. Let’s begin.

How Do Mortgage Overpayments Work?

Making overpayments on your mortgage simply refers to voluntarily paying more than the amount required by your lender. With a standard repayment mortgage, your agreed monthly payment will ordinarily cover both a proportion of the capital borrowed and the interest charged.

For example, if your monthly repayment is £1,000 and you choose to pay £1,100 instead, the additional £100 would then be classified as an overpayment that can help reduce your outstanding mortgage balance.

Provided your mortgage allows for overpayments, there is typically no fixed structure for making overpayments. Borrowers can usually start making extra mortgage payments at any point during their agreed mortgage term.

There are two main ways to make mortgage overpayments:

• Regular monthly overpayments: This is when you pay an additional amount on top of your required mortgage repayment each month.
• Lump sum overpayments: This is when you make a larger one-off payment directly towards your outstanding mortgage balance.

Many mortgage products allow you to overpay up to 10% of your mortgage balance each year without an early repayment charge (ERC). However, the exact limit and how it is calculated can vary between lenders and products, so it is important to check with your broker or lender beforehand.

With that said, the principle of how mortgage overpayments work is broadly the same. The overpayment reduces the capital you still owe. As mortgage interest is calculated against your outstanding balance, reducing that balance means there is less for your lender to charge interest on.

Is It Better to Make Monthly Overpayments or a Lump Sum Payment?

The quickest way to reduce mortgage interest is usually to make an overpayment as soon as the money is available.

For those who already have a lump sum available, paying it immediately will usually save more interest than spreading it across future monthly payments. However, making monthly overpayments can still help gradually reduce the outstanding mortgage balance and the amount of interest charged over time, while being easier to budget for each month.

When it comes to making overpayments on your mortgage, you do not need to choose one way or the other. Many borrowers use a combination of both, provided their total overpayments remain within any applicable limits if they want to avoid an early repayment charge.

For example, you might make a regular overpayment each month and then pay an additional lump sum after receiving a work bonus, inheritance or other unexpected funds.

This allows you to be proactive in reducing your mortgage balance each month, while making additional overpayments as and when more money becomes available, rather than sticking to one particular overpayment method.

When deciding whether to overpay mortgage monthly or lump sum, the amount of interest you can save largely depends on when the additional money is paid towards your mortgage.

To show how this works in practice, let’s compare the effect of making the same £12,000 overpayment at different points throughout one year. For this example, we have assumed:

• Outstanding mortgage balance: £200,000
• Interest rate: 5%
• Remaining mortgage term: 25 years
• Standard monthly repayment: £1,169
• Total overpayment: £12,000

These figures are illustrative. Actual mortgage interest and savings will depend on your lender, mortgage product and how and when interest is calculated.

Ultimately, there is not just one method that will suit every borrower when it comes to making overpayments. However, the earlier you can make the overpayment, the sooner it can start reducing the interest charged on your mortgage.

How Do You Make Extra Mortgage Payments?

If you are unsure how to make overpayments on your mortgage, the first step is always to check the terms of your current deal. Your mortgage offer and accompanying terms should outline whether overpayments are permitted and any limits or early repayment charges (ERCs) that may apply.

Depending on your chosen lender, there are several ways you may be able to make an overpayment, including:

• Increase your Direct Debit: For those looking to make monthly overpayments, some lenders will allow you to simply increase your regular mortgage payment so that you automatically overpay each month.
• Make a bank transfer: You may be able to send a one-off or recurring payment directly to your mortgage account using the lender’s payment details and your mortgage account number or reference.
• Pay online or through an app: Some lenders allow borrowers to make overpayments through their online mortgage account or mobile banking service.
• Contact your lender: If you are making a large lump sum or are unsure where to send the money, it’s always best to contact your lender. They will be able to explain in detail the available payment methods and any applicable limits.

Before making overpayments on your mortgage, it is important to check whether an early repayment charge could apply. As we have already touched on, many mortgage products limit how much you can overpay within a set period without a charge. As such, it’s always best to check your remaining allowance before making an extra payment.

How Much Can You Overpay Your Mortgage Without Paying Charges?

A 10% annual allowance is common among UK lenders for mortgage overpayments made without incurring an ERC. However, there is no single limit for how much to overpay on a mortgage without charges, as this is determined by the terms of your particular mortgage deal.

Some tracker, discount and variable-rate mortgage products have no early repayment charges. If your mortgage has no ERC or overpayment restriction, then you may be able to make larger overpayments, or even repay the mortgage in full, without an early repayment charge. However, it is always best to check the terms of your particular deal before making a final decision.

It is also important to check how your lender calculates its overpayment allowance. For example, some lenders base the allowance on your mortgage balance at the start of the year, while others may use the original amount borrowed or another method.

In addition, the allowance period can also vary depending on the lender’s policy and specific mortgage product.

As such, it is best practice not to assume that you can overpay 10% of your outstanding balance at any point without a charge. Always check your mortgage terms or ask your lender to confirm your current allowance, particularly if you have already made overpayments during the same period.

What Does the 10% Mortgage Overpayment Allowance Mean?

A 10% mortgage overpayment allowance simply refers to the amount you can overpay within the lender’s allowance period without incurring an early repayment charge (ERC).

For example, if your lender calculates your 10% allowance using a mortgage balance of £200,000, you could overpay up to £20,000 during that allowance period without incurring an ERC.

Importantly, the 10% does not necessarily refer to your current outstanding balance. As discussed above, lenders can use different methods to calculate the allowance, so always check which figure your lender uses when calculating your overpayment limit.

Should You Reduce Your Mortgage Term or Increase Monthly Payments?

Reducing your mortgage term will usually result in higher monthly repayments becoming mandatory. With fewer years to clear the outstanding balance, you will be contractually required to pay more each month, leaving much less flexibility if there is a change in your finances.

It’s no secret that life does not always go to plan. Losing your job, separating from a partner, taking time off to have a child or sudden increases in the cost of living can all directly affect how much money is available at the end of each month. But if you have committed to a shorter mortgage term, you will still need to meet the higher contractual repayment.

Alternatively, you could keep your existing mortgage term and voluntarily increase your monthly payments through overpayments. This can still help you clear the mortgage sooner, but without necessarily committing you to a permanently higher contractual repayment.

For example, if your mortgage repayment is £1,000 a month, but you can comfortably afford £1,300, you could consistently make a £300 monthly overpayment. Then, should your circumstances later change, you still have the option to reduce or even stop that £300 overpayment, and return to your required £1,000 payment.

Some lenders may offer further flexibility by allowing underpayments after you have previously overpaid your mortgage. Depending on the mortgage terms, this could allow you to temporarily pay less than your usual monthly repayment, using some or all of the amount you have previously overpaid.

However, underpayment rules vary considerably between lenders and mortgage products, and so it is always best not to assume that making an overpayment automatically allows access to the possibility of an underpayment later.

For this reason, keeping a longer term while making voluntary overpayments can provide greater financial flexibility. Just remember that any overpayments are subject to your lender’s overpayment limits and mortgage terms.

What Are the Benefits of Overpaying Your Mortgage?

The main benefits of overpaying your mortgage include:

• Pay less mortgage interest: Reducing your outstanding balance means there is less capital for your lender to charge interest against.
• Clear your mortgage sooner: Maintaining your usual repayment alongside overpayments can help you repay the outstanding balance ahead of the original mortgage term.
• Reduce the overall cost of borrowing: Paying less interest over the life of your mortgage can reduce the total amount you repay compared with making only your required monthly repayments.
• Build equity in your property faster: Overpayments reduce the amount you owe against your property, helping you build equity faster.
• Potentially improve your loan-to-value (LTV): A lower outstanding balance can help reduce your LTV, which can put you in a stronger position when you remortgage.

If you are aiming to reduce the interest you pay and potentially clear your mortgage sooner, overpayments can provide clear financial benefits. However, it’s crucial to consider your wider financial position. Whether making overpayments is the best use of your money will ultimately depend on your individual circumstances.

Is It Better to Overpay Your Mortgage or Save Your Money?

When deciding whether to save or overpay on your mortgage, start by comparing your mortgage rate against the interest you can earn on your savings.

Let’s look at this example in practice and which offers the better financial return:

This is an illustration before any applicable tax on savings interest. Actual mortgage interest savings will depend on when the overpayment is made and how your lender calculates interest.

As the table shows, the higher interest rate can indicate where your money could provide the greatest financial benefit.

With that said, it’s also important to remember that savings interest may be taxable depending on your circumstances, while money held in savings remains accessible if you need it.

How Much Will You Save By Overpaying Your Mortgage?

The amount you can save will depend on your mortgage interest rate, outstanding balance, remaining term and how much you overpay.

As a general rule, larger and earlier overpayments can result in greater interest savings.

Let’s look at an example of the potential effect of making a one-off £10,000 lump sum overpayment immediately. For this example, we have assumed:

• Outstanding mortgage balance: £200,000
• Interest rate: 5%
• Remaining mortgage term: 25 years
• Monthly repayment: £1,169
• One-off overpayment: £10,000 paid immediately
• Future monthly repayment: Remains at £1,169

The figures above are illustrative and have been rounded for clarity. Actual interest savings and the time taken to repay your mortgage will vary depending on your mortgage terms.

Using an online mortgage overpayment calculator can help you compare different overpayment amounts and estimate how much interest you could save or how much sooner you could repay your mortgage.

How Can a Mortgage Adviser Help You Decide?

Deciding whether to overpay your mortgage, and by how much, is not always as straightforward as having spare money available. It is important to consider your mortgage interest rate, remaining term, overpayment allowance, potential ERCs and whether keeping the money in a savings account could actually be more suitable for your circumstances

A mortgage adviser can help you review these factors alongside the terms of your current deal and explain the options available to you. This expert insight can be particularly useful if you are approaching a remortgage, considering a large lump sum payment or simply need more information on whether making overpayments on your mortgage is the right decision for you.

At Boon Brokers, our fee-free mortgage advisers can help review your current mortgage and explain all of your overpayment options. Whether you are considering making regular overpayments, have a lump sum available or are approaching the end of your current deal, we’re here to help.

Contact us today to discuss your mortgage and explore all the options available to you.