Should you overpay your mortgage?

Mortgage rates have risen in the UK, reaching their highest levels since 2008 in 2023.

Despite the recent Bank of England interest rate cut, average two-year fixed mortgage rates sit at more than 5%, according to Moneyfacts, up from the 2.34% average rate in 2021.

This will likely be a worry for the estimated 1 million homeowners whose fixed rate mortgages are due to come to an end this year. A new mortgage will be far more expensive and monthly payments will be higher.

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The higher costs of borrowing will have had a notable impact on household finances – and to the housing market.

If you have a mortgage deal that was secured before rates started climbing, here's what the experts say you need to think about.

Should you overpay your mortgage?

Before deciding to overpay your mortgage, there are several considerations, says Jo Jingree, MD of mortgage advice firm Mortgage Confidence.

Chief among them, she says, is whether you have sufficient savings to weather a financial emergency. She adds: “Overpaying your mortgage is a fantastic idea but only if you have a good level of savings first and foremost.

"Also consider if your lender will charge you an early repayment charge for the overpayment – most lenders allow overpayments of up to 10, or even 20% of your balance per annum but not all, so always check before you overpay.”

What to do before overpaying your mortgage

1. Pay off high-interest debts

Anyone thinking about overpaying on their mortgage should first pay down expensive debt, such as credit card bills or overdrafts, says Laura Suter, head of personal finance at AJ Bell.

If you have savings and also interest-bearing debts, it will almost always make sense to use the savings to pay off the debts as they will cost you more than you’ll save by ploughing money into your mortgage.

Example:
Someone who has £1,000 in an account earning 4% interest, but owes £1,000 on a credit card at 19.9%. Over a year you would earn £40.74 interest on your savings, but you would have to pay £93 in interest on your credit card, even if you paid off £100 a month. 

So the most profitable option is to use your savings to clear the debt and avoid paying interest at such a high rate.

2. Create a rainy day fund

After you've paid off any expensive debts, you should build up a cash buffer to cover between three and six months of expenses to fall back on if you hit an expected financial bump in the road.

Once you've paid money into your mortgage, you can’t get it back, so ensure you have enough in your emergency savings fund first. It’s wise to keep money in an easy-access account so you can get it when you need it, for events such as a broken boiler.

3. Check your mortgage provider allows overpayments

If you have a fixed-rate or a discounted-rate mortgage it is likely to have early repayment charges which could be triggered by overpayments. Those charges would easily wipe out any interest savings. So, it's important to check what your lender’s rules are on overpayments before you start making them. 

Many lenders will allow you to overpay as much as 10% of your outstanding mortgage debt each year. If you are on a variable-rate mortgage you may be able to overpay more. You can usually make overpayments by increasing your monthly direct debit or by making one-off transfers.

Those on a standard variable rate – to which a mortgage reverts after a fixed term expires – will typically have no restrictions on overpaying. Though you should check with your lender first.

4. Consider adjusting your mortgage term

Instead of overpaying, when it is time to remortgage, it is possible to adjust the terms of a mortgage to shorten the term - meaning you pay it off sooner.

The impact will be higher monthly repayments but you’ll pay the loan off faster. However, this isn’t as flexible as overpaying, where you can vary the amounts you overpay by each month.

Benefits of overpaying your mortgage

The sooner you pay off the loan, the less interest you will pay. Overpaying will help to drive down the actual mortgage balance on which you are charged interest and help you pay it off faster.

With many people still benefiting from cheaper loans at the moment it could make a lot of sense for borrowers to think about making the most of those low rates.

“Overpaying each month, even if it is as little as £100, will likely save you money in the long run,” says Brian Murphy, head of lending at Mortgage Advice Bureau. “It also offers you more flexibility if you come into a situation where you need that extra cash – you can simply lower your payment to the pre-agreed amount.

“Paying in one large lump sum will likely help you clear the mortgage faster and will certainly reduce the interest you are paying.”

Nicholas Mendes, mortgage technical manager at John Charcol, agrees: "By making extra payments towards your mortgage principal, you can reduce the outstanding balance faster and pay less interest in the long run."

Example:
Someone who borrowed £200,000 over 25 years, with an interest rate of 4.5%, would have mortgage repayments of £1,111 a month.

• Overpaying by £200 a month would save you around £36,281 in interest and see you pay your mortgage off six years earlier than planned. 
• Overpaying by £100 a month would save you around £21,142 in interest and see you pay your mortgage off three years and six months earlier than planned.

Mendes adds: “As you make mortgage overpayments, you're effectively building equity in your home at an accelerated rate. Increased equity provides you with more financial stability, whether you decide to move home or release equity for home improvements.

“By reducing your outstanding mortgage balance, you'll be better prepared to handle market fluctuations. When interest rates rise, having a lower outstanding balance can cushion the impact on your monthly mortgage payments.”

Using some of your savings to reduce your mortgage debt might also benefit you if it places you into a lower loan-to-value (LTV) bracket.

For most lenders the cheapest mortgage rates are offered to those with an LTV of 60% or less. So if your LTV was just above that, using savings to pay off some of the mortgage means you could benefit from a reduced rate of interest when you next come to remortgage.

Mortgage overpayments or higher pension contributions

There are many reasons why putting extra money into your pension might make more sense than making mortgage overpayments.

“Money that's put into a pension will benefit from tax relief. It also benefits from often being invested in the stock market for a long period of time, enjoying the magic of compound interest and the possibility of riding out any volatility in the markets,” says Karen Noye, mortgage expert at Quilter.

The tax relief in itself is valuable. You get 20% paid into your pension by HM Revenue & Customs and higher or additional rate taxpayers claim relief on your self-assessment tax return at either 40% or 45%.

Plus your money gets to grow tax-free. By prioritising mortgage contributions earlier on in life, you could be giving up valuable investment growth.

The amount your pension grows each year depends how it is invested. But a recent study by Pension Bee revealed that pension funds have been delivering an average annual growth of nearly 8% over five years for those 30 years from retirement.

“Even if pensions grow between 2% and 3% a year, over a long period and with a larger amount in the pot, this does add up,” says Murphy from the Mortgage Advice Bureau (MAB).

Additionally, even though mortgage rates will remain elevated in the short-term it's likely they will come back down. So, it might not make sense to put all of your extra cash towards your mortgage.

“Investing in the stock market has historically given the greater return particularly when invested via a tax-efficient product like a pension,” says Noye. “Therefore together the power of tax relief and fund growth over a long-term horizon may make it better to allocate additional funds to your pension especially if you are paying more than just the basic rate tax.”

A 2024 study by interactive investor runs through a number of scenarios, crunching the numbers on the question of prioritising mortgage overpayments or pension contributions.

The table below details an example of someone with a £200,000 mortgage, over a 25-year term, with a spare £200 each month and on the basis interest rates remain static. Here’s how the money would change their potential outcomes depending on whether they focused on mortgage overpayments first, or went straight to pension contributions.

Assumptions: 25-year repayment mortgage, 20% tax relief.
Option 1,2 & 3 - overpayment into mortgage or pension of £200 per month.
Option 1 & 3 - once the mortgage is paid off, divert mortgage payment into a pension, returns net of investment fees.

As Myron Jobson, senior personal finance analyst at interactive investor, notes, the reality is that interest rates do not remain static, so at different points it may make more financial sense to focus on either savings, mortgage overpayments or pension contributions.

The role of tax relief on pension contributions is also a crucial consideration. Jobson says: “If you’re a higher rate taxpayer, it’s also possible that you won’t get as much tax relief if you decide to wait to boost your pension wealth. It’s possible that you’ll not earn enough in the future to get a higher rate of tax relief if you pile a large amount into your pension in just a few years.”

How do I overpay my mortgage?

Once you’re clear on how much you can overpay without penalty you can start to plan your overpayments.

You might have already been in touch with your lender to discuss the limits but it’s important to make them aware you’ll be overpaying, by how much and when.

You can either pay a lump sum to your mortgage account or set up regular payments to be made.

Can you overpay on an interest-only mortgage?

Interest-only mortgages normally allow you to make overpayments either as a lump sum or through increased monthly instalments.

In most cases the capital won’t reduce, so you will still be paying interest on the whole borrowed amount every month.

Yet the overpayments should directly reduce the outstanding loan balance, making the final repayment amount smaller.

Like a repayment mortgage, if your existing loan is still within the fixed period you will need to be mindful of overpayment limits so you don’t trigger an ERC.

Should I overpay my mortgage monthly or yearly?

Chipping away at the overall amount you borrowed means reducing the amount of interest you pay.

So if you have a lump sum at the beginning of the year then that’s ideal. But if can’t afford to do that, a monthly overpayment is the next best thing.

Speak to your lender or broker about your plans before going ahead.

Should you overpay your mortgage? The verdict

As with all financial matters, there is no one-size-fits-all answer. What you do will depend on your priorities, circumstances and appetite for risk.

If you think ultra-low mortgage rates might make a comeback, then putting the money towards your pension and letting interest compound might be more appealing than paying your mortgage off quickly.

If you think you might need this extra cash for any reason in the near term, then keeping it in a savings account that you can access easily may make more sense.

Factors as varied as your age, mortgage term, mortgage product and available savings rates will have a bearing on the calculations. As ever, it's worth taking expert advice before making these decisions.