Should you overpay your mortgage?

With interest rates at a 16-year high, should you overpay your mortgage - or could you put extra cash to better use?

Cash, a calculator and a model house with a key
Your mortgage is likely to be the biggest debt you ever take on
(Image credit: © Getty Images)

If you have some spare cash left over at the end of the month, are you better off overpaying your mortgage or topping up your pension pot?

Mortgage rates have risen for 80% of households over the last two years, with around 1.5 million homeowners set to be hit by them in 2024. While there had been hopes that they would fall in 2024, we are coming off the back of the third distinct set of mortgage hikes since late-2022. These increases have had a notable impact on the housing market.

Worse-than-expected economic data has been behind the latest set of price rises. Inflation remains above its 2% target, which has delayed Bank of England interest rate cuts - a major factor in mortgage pricing. The general election may also have delayed cuts.

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Average two-year fixed mortgage rates sit at 5.92%, according to Moneyfacts. If you're on a deal that dates back to before rates shot up, 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 you need to make, 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."

When should you start overpaying your mortgage?

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.

“Once that’s done you need to 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.”

With interest rates rising, there are a growing number of highly competitive savings accounts on the market. After that, you need to check that your mortgage provider allows repayments. Some might limit overpayments to a percentage of what you owe, while others might charge early repayment fees. You also have to decide how much you can afford to overpay, and whether you want to overpay monthly or as a one-off.

“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 fee.”

“Paying in one large lump sum will likely help you clear the mortgage faster and will certainly reduce the interest you are paying. However, if you suddenly need that extra money back, you won’t be able to withdraw it from the mortgage, so only do this if you know you won’t need that money.”

The benefits of overpaying your mortgage

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

With an interest rate of 3%, someone who borrowed £200,000 over 25 years would pay £948 a month. Overpaying by £200 a month would save you around £21,620 in interest and see you pay your mortgage off six years earlier than planned. Someone with the same mortgage on a 6% interest rate could make a saving of £32,017 by overpaying £100 a month.

Mendes adds that it could bring down your monthly payments sooner. He says: "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."

You may also be able to pay off your mortgage sooner than expected, which would "eliminate a significant monthly expense" and give you "peace of mind", Mendes says.

Should you prioritise pension contributions?

If you decide to overpay, it’s important not to compromise your pension contributions. Indeed, there are many reasons why putting extra money into your pension might make more sense.

“Money put into a pension benefits from tax relief and 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 early years of saving for retirement are important due to the effect of compound interest, or the interest you earn on interest. By prioritising mortgage contributions earlier on in life, you could be giving up valuable investment growth.

“Most pensions will grow between 2% and 3% a year which might not seem like much, but over a long period and with a larger amount in the pot, this does add up,” says Murphy from 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.”

MORTGAGE OVERPAYMENTS VS HIGHER PENSION CONTRIBUTIONS

A 2023 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.

The table below shows extra pension wealth after 25 years:

Swipe to scroll horizontally
6% interest rates, 5% investment growth6% interest rates, 6% investment growth5% interest rates, 6% investment growth
Option 1Overpaying mortgage first and then pension (with tax relief)£165,901£171,455£152,758
Option 2Paying into pension first£148,877£173,248£173,248
Option 3Overpaying mortgage first and then pension (no tax relief)£132,720£137,164£122,224
Difference between options 1 & 2£17,024£-1,793£-20,490

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 mortgage is paid off, divert mortgage payment into pension, returns net of investment fees

As Alice Guy, personal finance editor 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 mortgage overpayments or pension contributions.

The role of tax relief on contributions is also a crucial consideration. Guy 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 higher rate tax relief if you pile a large amount into your pension in just a few years.”

THE VERDICT

As with all financial matters, there is no straightforward 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 somewhere you can access it easily will make more sense.

If you want to prioritise paying your mortgage off early so that you know it’s one bill you don’t have to worry about later on, or just because you want to tick it off your list of goals, then that might seem like the obvious choice.

Things such as your mortgage term, interest rate, age and job status will also factor into the equation. As ever, it's worth talking to a mortgage broker when making these decisions.

Henry Sandercock
Staff Writer

Henry Sandercock has spent more than eight years as a journalist covering a wide variety of beats. Having studied for an MA in journalism at the University of Kent, he started his career in the garden of England as a reporter for local TV channel KMTV. 

Henry then worked at the BBC for three years as a radio producer - mostly on BBC Radio 2 with Jeremy Vine, but also on major BBC Radio 4 programmes like The World at One, PM and Broadcasting House. Switching to print media, he covered fresh foods for respected magazine The Grocer for two years. 

After moving to NationalWorld.com - a national news site run by the publisher of The Scotsman and Yorkshire Post - Henry began reporting on the cost of living crisis, becoming the title’s money editor in early 2023. He covered everything from the energy crisis to scams, and inflation. You will now find him writing for MoneyWeek. Away from work, Henry lives in Edinburgh with his partner and their whippet Whisper.

With contributions from