Should you overpay your mortgage?
Overpaying your mortgage could knock years off your repayment period and save you thousands of pounds in interest. Ruth Jackson explains the pros and cons of overpaying your mortgage, and how to go about it.
In the first three months of 2022 almost £5.1bn was overpaid on mortgages, according to the Bank of England. The overpayments continue a theme: 2021 was a record year, with £21.8bn cleared off mortgages by people making extra payments.
Why are so many people choosing to repay more than they have to? The answer is to save money and cushion against future interest rate rises.
“Although the cost of living is rising, it could still be a good time to consider overpaying if there’s any flex in the monthly budget, especially for those borrowers that managed to secure the very lowest rates that were available before the base rate started to climb,” says David Hollingworth from L&C Mortgages.
“Making the most of a current low rate will help to drive down the capital balance more quickly and can save thousands in interest over the life of the mortgage. That will help when current deals come to a close and help to mitigate any rate shock, if rates continue their upward trajectory.”
How can overpaying my mortgage help?
Your mortgage is likely to be the biggest debt you ever take on and borrowing hundreds of thousands of pounds means you pay a lot of interest back to your lender. Over the course of a 25-year mortgage, someone who initially borrowed £200,000 can expect to pay around £84,500 in interest, assuming an interest rate of 3%.
However, the faster you repay your debt the less interest you pay. In the above example, someone overpaying their mortgage by 5% every year would be mortgage-free nine years and nine months earlier, saving them £40,000 in interest.
Overpaying doesn’t only save you money, it also improves your chances of being approved for a better interest rate when it is time to remortgage. This is because the more you overpay the less capital you will owe, which means your loan to value (LTV) will be lower, giving you access to better rates.
The final reason to consider overpaying is that it also puts you in a better position for passing a lender’s affordability checks when you go to remortgage. When you apply for a new mortgage, you will have to pass your new lender’s affordability checks. With inflation soaring, the figures used by lenders for average household spending in their affordability calculations are going to rise. If your income hasn’t risen, this means you may find yourself failing those checks.
If you’ve been overpaying your mortgage, then when you remortgage, you stand a better chance of having lower repayments on your new deal – both because you will be borrowing less capital and because your LTV may mean you get a lower interest rate – giving you some breathing space on those affordability sums.
How much can you save by overpaying?
There are big savings to make when you overpay your mortgage. Let’s look at someone with a 25-year £200,000 mortgage taking on a new five-year fixed rate mortgage. Assuming they get the best deal, their interest rate will be 2.2%.
If they made a 10% overpayment each year, they would save £37,125 in interest over the life of their mortgage and clear their debt 13 years and two months early.
To add to the attraction that person would owe £91,234 after five years when it was time to remortgage. That’s a massive £77,000 less than if they hadn’t made any overpayments, putting them in a very strong position when it comes to getting a new mortgage deal – even if interest rates have gone through the roof.
“By paying off the mortgage more quickly it will mean a smaller mortgage to deal with in what could be a higher rate environment but could also help to push down the proportion of the property value that you need to borrow,” says Hollingworth. “The lower the loan to value is, the better the choice of rates and lenders is likely to be and could open up cheaper options.”
Should I overpay my mortgage?
With interest rates on the rise, anyone with money in the bank should consider paying down their debts to cut future costs. One option is to overpay your mortgage, and as we’ve shown, it can result in huge savings. But it is likely to be one of the lowest-interest debts you have. If you have other debts with higher interest charges – such as an overdraft or credit card – focus on clearing them first.
Once your more expensive debt is cleared you can start thinking about overpaying your mortgage. However, only use money you aren’t going to need in future. Once you’ve made an overpayment you can’t ask your lender for the money back, so make sure you have a healthy emergency savings pot first.
How much can I overpay on my mortgage?
Another point is that before you start bumping up your mortgage repayments, you need to check the terms and conditions of your mortgage deal to see if overpayments are allowed.
If you are on a fixed deal, there are likely to be restrictions on overpayments. Usually, you can overpay by up to 10% a year. If you go over that amount you will trigger early repayment charges that are likely to wipe out any savings you had hoped to make.
Anyone on their lender’s standard variable rate (SVR) should be able to make overpayments without penalty. But again, check your terms and conditions.
There are two ways to make overpayments on your mortgage. You can usually increase your monthly direct debit so you are paying off a little bit extra every month or you can make one-off overpayments. Speak to your mortgage provider to find out how you can go about making overpayments.