Is it Better to Overpay or Reduce your Mortgage Term?

For most people, a mortgage will be the largest financial commitment you’ll ever make, and so it’s important to know how you can keep the total loan repayments down to a minimum.

As your financial circumstances change, you may find yourself in the position to be able to overpay on your mortgage, or even shorten the term length. But how can this help?

In this short guide, we will explore the pros and cons of overpaying your mortgage, helping you determine the best choice for you.

Short on time? Check out our quick video guide below:

What is Overpaying on Your Mortgage?

Overpaying your mortgage involves making extra payments on top of your agreed repayment mortgage plan. Should your lender allow you to make an overpayment, you can decide how much additional money you wish to contribute.

There is no commitment to overpayments, and as such you are in control of when and of how much you wish you overpay. For example, the additional payment could be as little as £50, or it could be £1,000 – it all depends on your affordability and how much your lender will allow you to overpay.

The key advantage of overpaying your mortgage is that it allows you to repay your mortgage loan off faster, reduce the term of mortgage, and save on a reduction in mortgage rates.

What is Reducing Your Mortgage Term?

Reducing your mortgage term is very similar to overpaying your mortgage, just with an alternative outcome. Instead of making overpayments on your mortgage, you formally arrange with your lender to adjust the term of a mortgage.

For example, should your mortgage have 22 years remaining, you could choose to reduce the mortgage term to 17 years. The result of which means that your minimum monthly payments will increase, but you’ll pay off the overall mortgage loan sooner. This option can save a significant amount of interest.

What are the Benefits and Drawbacks of Overpaying the Mortgage Term?

Before deciding whether or not to overpay your mortgage, it’s important to first weigh the good against the bad. Let’s dive into all of the advantages and disadvantages of overpaying your mortgage:

Benefits

Flexibility in Mortgage Overpayments

The main benefit of overpaying mortgages is the flexibility that it can offer. With overpayments, you are in the driver’s seat – you can stop overpaying whenever you want to, or decide to continue overpayment and lower loan repayments, and by proxy,  the overall mortgage term time.

Simple, as long as you stay within your lender’s overpayment criteria, you can increase or decrease your contributions as and when you see fit.

Drawbacks

Overpayment is Not Always an Option

Unfortunately, not all lenders will allow you to make overpayments.

Overpayment Fees

When paying a mortgage off early, some lenders will apply a fee if you overpay a higher amount than what is allowed. In this scenario, you would no longer be saving as much money compared to a reduced mortgage term option.

Maximum Overpayment Amount

With most fixed rate products – which is currently the most in-demand option – you may only be able to pay up to 10% of the outstanding amount each year. However, if your financial circumstances allow you to afford to pay more, then a reduced term loan could be the best option to reduce mortgage interest.

As the maximum overpayment amount is set by each lender, you might not be able to use it to pay off your mortgage straight away.

There are some mortgage products, such as Tracker, Discount, and Standard Variable, that typically have no overpayment restrictions. As such, if your financial standing is likely to change, or if you are planning to make large overpayments in the future, these products match your needs.

What are the Benefits and Drawbacks of Reducing the Mortgage Term?

Just as we explored the ins and outs of overpaying your mortgage, let’s now explore all the advantages and disadvantages of reducing your mortgage:

Benefits

Potentially Save More

A massive benefit to reducing the mortgage term length is that you could save much more money. While overpayments leave the decision making to be made at regular intervals, reducing the mortgage term is set.

Due to there being a formal agreement in place, you will be obliged to continue making your new agreed upon monthly payments.

Consistent Payments

As the reduced term is formally agreed upon, there are no surprises. As such, you can make financial plans, knowing exactly how much you will need to pay each week.

Drawbacks

Less flexibility

The main consideration and drawback to shortening a mortgage term, is the unpredictability of life.

Committing to making a higher mortgage payment does place increased pressure, and the reality is that people can be made redundant, go through breakups, or even become ill and unable to work.

Unfortunately, the additional repayments on the mortgage would be much harder to continue in any of these scenarios.

Less Disposable Income

With the agreement of making higher mortgage repayments, it follows that you might have less disposable income. As such, luxury lifestyle choices – like weekends away – and other non-essential purchases will be less affordable.

Should I Overpay My Mortgage or Reduce the Term?

Importantly, there is not a single right or wrong answer. As we’ve explored, both options have their own benefits and drawbacks – it is what works for your situation.

Regardless of which option you choose, the overall amount you can save will vary as it will be directly influenced by interest rates, overpayment limits, and any additional fees set out by your specific lender.

In addition to this, the type of mortgage you have is also an important factor. While a fixed-rate mortgage will offer a consistency, a variable-rate mortgage product could be subject to rising interest rates. As such, you might find yourself committing to a shorter mortgage term, only to find the increased interest rates make repayments unaffordable.

Generally, reducing the term of a mortgage can lead to a greater saving overall. This is because an agreed upon rate forces you to pay off mortgage repayments, reducing the overall interest. Those with job security may feel confident to commit to a shorter mortgage term. However, there is less flexibility and unforeseen circumstances could leave you struggling with the once agreed upon higher repayments.

On the other hand, overpayments – making additional mortgage payments – will provide a less rigid structure with much more flexibility. Overpayments do still allow for a large amount of savings, as long as the payments remain consistent.

Ultimately, you will have to apply the options directly to your circumstances: is maximising savings worth sacrificing the financial flexibility?

Some Other Considerations

Before you decide whether to reduce the term on a mortgage, you should consider whether it is the right time to do it.

Just like any other time you arrange a new mortgage deal, you should consider details such as whether you can arrange a lower mortgage deal due to reaching a better LTV (loan to value) ratio.

If you have a 60% LTV rather than 65%, then you could be eligible for a deal with a lower interest rate. Therefore, paying the mortgage over a shorter period would be more affordable than doing it at 65% LTV.

Speaking to an adviser will help understand the options that are available to you. They will be able to provide calculations to show you the difference between overpaying or reducing your mortgage term.

They will look at your specific circumstances, such as income, other financial commitments, age, job security and other individual factors that will influence the suitability of each option.

How Boon Brokers Can Help You With Overpayment and Mortgage Term Reductions

Boon Brokers provides expert mortgage advice based on your specific financial circumstances, to ensure that you choose the best option for your short and long-term finances.

Contact our mortgage team today and we can help you to get started with your mortgage application and enable you to get onto the property ladder. Boon Brokers offers a fee-free, whole-of-market, mortgage advice and arrangement service