How Does Overpaying Your Mortgage Work?

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The financial benefits of overpaying on your mortgage can be significant, so if you are in a position to pay more than you are currently paying, it is worth assessing how much you could save by overpaying. This article explains how overpaying works and the factors that influence whether it is the right choice. Once you have read this, you should have a better idea of whether it is a good option depending on your circumstances.

The idea of overpaying does not appeal to everyone. For example, first time buyers who are paying a monthly mortgage payment on top of additional living costs for the first time are not likely to want to be paying even more each month. However, for people who have more expendable income, overpaying their mortgage often works out to be very beneficial.

How overpaying works

There are two different options for overpaying your mortgage, you could either arrange to increase your monthly mortgage payments, or you could pay off a lump sum against your outstanding mortgage loan. If you receive money through inheritance, or a salary bonus payment, for example, you might want to consider overpaying your mortgage.

In regard to increasing your monthly payments, if you are finding that you have more money left at the end of the month than you are spending, then it would usually make sense to increase your mortgage payments.

Key benefits of overpaying your mortgage

When you make overpayments on your mortgage, you are able to pay your mortgage off quicker. So, instead of it taking 25 years to pay your mortgage off, you could realistically reduce it to 22 years or even less. You do not pay interest on the amount that you overpay, so savings are made through this.

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Some people consider taking out a re-mortgage over a shorter length of term, so that they can pay off their mortgage quicker, but in most cases, having the flexibility of overpaying your mortgage is better because you can easily stop overpaying if your situation changes.

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How much can you save by overpaying a mortgage?

The exact amount will depend on your specific mortgage deal and how much you decide to overpay but to give you an example:

If you had a mortgage of £150,000 over 20 years with an interest rate of 5%, the total you would pay on this rate would be £237,584.

If you were to overpay by £100 each month, you could bring this down to £223,327.

Overall this would save you about £14,300 which would allow you pay your mortgage off almost 3 years earlier.

You can use a mortgage repayment calculator to find out exactly how much you could save by overpaying on your mortgage, based on your own mortgage details.

Savings vs overpaying your mortgage

A question that gets asked frequently is whether it is better to put money into a savings account, or to overpay on a mortgage. This all depends on how much the interest rates are. Interest rates on saving accounts have not been very high for some time, so overpaying your mortgage could be the better option at the time of publishing this article.

If you are paying 3% interest on your mortgage but your savings account is only 1.5% interest, any spare money you have would work harder for you if it was overpaying your mortgage. For higher rate taxpayers who have used up their personal savings allowance, they stand to lose even more by putting their money into savings rather than overpaying their mortgage.

You should always keep an eye on savings interest rates, as if they do improve at some point, you may then have the option of gaining more interest on savings rather than overpaying your mortgage.

Overpaying vs paying off other debt

Another factor to consider is any other outstanding debt you have. If you have a car loan, or another type of debt that has a higher interest rate than your mortgage, you would usually be better paying this off before you start overpaying on your mortgage.

So, if you have any credit cards, store cards, or any other type of credit with a higher interest rate than your mortgage interest rate, you should be looking to pay these off as a priority.

Doing this can also help to improve your credit file, so if you need to apply for a loan in the future, having less outstanding debt is favourable.

Limitations on overpaying

Not all mortgage deals allow you to make overpayments without paying a penalty, but many will let you overpay up to a set limit before you do incur any penalties. Generally, mortgage lenders will allow borrowers to overpay up to 10% of the mortgage balance each year without a charge being applied but this varies from lender to lender. Lenders will often apply a charge of between 1-5% on any overpayments that are over the agreed limit.

When you are taking out a mortgage, you should look out for overpayment penalties. Even if you are not looking to overpay at the current time, you might find yourself in the position where you are able to overpay at some point in the future. If you were to get charged 5% of your overpayment, it may not work out to be very worthwhile.

The main reasons lenders apply an overpayment penalty is to try and earn as much interest from you as they can before you are able to move to another lender when a fixed deal ends.

Other considerations

Another factor to consider when you are deciding whether overpaying is worthwhile, is the possibility of unexpected costs you may need to pay for. Some people keep an emergency fund to one side to enable them to pay for unforeseen costs such as a roof repair, or to replace a broken TV, for example.

If you have spent your spare money overpaying your mortgage but then you have a few thousand pounds you need to find from somewhere, you could end up taking out credit and paying more interest than you are saving by overpaying.

So, while it is generally a good idea to put spare money towards overpaying your mortgage, you should also have a small saving pot aside, to avoid the need to take out credit. But there are other options, such as taking out 0% credit cards for situations like unexpected costs, so it pays to be financially savvy.

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Overpaying on your mortgage is not always the best option if you have other outstanding debts or if there are high penalty charges attached to your mortgage deal. However, for the majority of mortgage borrowers, overpaying on their mortgage each month allows them to make considerable savings on their interest and enables them to be mortgage-free much earlier.

If they pay their mortgage off three years early, they can put the equivalent of their monthly mortgage payment into their pension or look at other ways to earn interest on their money before retirement.

Overpaying a mortgage is a more flexible option compared to taking out a new mortgage deal and reducing the loan term, so if something unexpected happens such as being made redundant or a large unforeseen cost arises, you can simply stop overpaying.

Using a broker can ensure that you find mortgage deals where you are able to overpay your mortgage and a broker can also find the best deals in terms of having less limitations on overpaying.

If you would like some advice on whether overpaying your mortgage, Boon Brokers will be happy to discuss your circumstances to help you to decide if it is the best financial option for you.

Gerard BoonB.A. (Hons), CeMAP, CeRER

Gerard is a co-founder and partner of Boon Brokers. Having studied many areas of financial services at the University of Leeds, and following completion of his CeMAP and CeRER qualifications, Gerard has acquired a vast knowledge of the mortgage, insurance and equity release industry.