For many homeowners the dream is to become mortgage-free. Overpaying is one way to get closer to that dream because overpaying on your mortgage clears the debt more quickly. But before you take the plunge, find out everything you need to know in our guide to overpayment.
What is a Mortgage Overpayment?
A mortgage overpayment is when you pay more than your standard monthly mortgage payment in order to pay off your mortgage more quickly.
If you are on a fixed-rate, tracker or discount mortgage then most lenders will allow you to overpay by up to 10% of your mortgage balance a year without any penalties – so for every £100,000 you’ve borrowed you can overpay by up to £10,000 per year.
Mortgages on the Standard Variable Rate (SVR) usually allow you to overpay as much as you like but they may include a redemption penalty for paying off your mortgage early. However, if you are on an SVR then you are probably paying a higher interest rate and so it might be financially wiser to look into remortgaging to secure a lower interest rate before you think about overpaying.
Always check with your lender what their rules are regarding overpaying before you go ahead as some lenders will charge you hefty fees if you overpay more than you are allowed.
Overpaying on your mortgage not only helps you to pay off your debt more quickly but it also means that you will end up paying less interest over the lifetime of the mortgage thereby saving you money.
For example: If you took out a £150,000 mortgage at a rate of 2% interest which would be paid off over a 25 year term you would pay about £635 a month.
If you overpaid £100 a month then over the course of the mortgage you would save £7,295 in interest and you would pay off the mortgage a little over 4 years early.
If you preferred to overpay in a lump sum and paid off £5,000 in one year but thereafter kept the mortgage payments the same then you’d pay £3,131 less in interest and would pay the mortgage off nearly a year early.
How to Overpay on Your Mortgage
Before going ahead with making an overpayment check with your lender if they impose any fees on overpayment.
If you have established that you are free to make overpayments then you can usually do so by adjusting your monthly direct debit to your lender.
However, it is usually worth speaking to your lender before you start making overpayments on your mortgage just to keep them updated on your plans.
Pros and Cons of Overpaying Your Mortgage
It’s always worth thinking through all the positives and negatives associated with overpaying your mortgage to make sure it is the best option for you.
Pros:
- By overpaying you are chipping away at your mortgage debt, meaning that ultimately you will pay off your mortgage more quickly.
- You don’t pay interest on any amount you overpay.
Cons:
- If you want to overpay by more than 10% of your mortgage balance a year then you may be subject to penalties.
- If you move money from savings to overpay on your mortgage then that money is no longer accessible.
Is it Better to Overpay Monthly or in a Lump Sum?
There’s a fair amount of complex maths needed to answer this question.
Broadly, it depends on how much you’ve borrowed and over how long plus how much you plan to overpay by and for how long for.
It depends on what your current mortgage product is too – whether you’re already repaying some of the capital monthly or if you’re paying interest only.
Most mortgage products calculate interest daily so each month where you’ve borrowed less will mean you pay less interest.
How you want to overpay your mortgage depends very much on your own personal circumstances. To get tailored advice on overpaying your mortgage speak to one of our advisors today.
Do Mortgage Overpayments Reduce the Capital?
Yes. Your standard monthly payment takes care of the interest on your loan (and, depending on your mortgage product, some of the capital too) so any extra payments will solely go towards paying off your capital debt.
If you have a repayment mortgage you can ask your lender to keep your mortgage payments at the same rate even after you have paid off a lump sum and this will mean that each month your monthly payments will pay off more off the capital of your loan which ultimately means you will pay your mortgage off more quickly too.
How much can I Overpay on my Mortgage?
Most lenders and mortgage products allow you to overpay up to a maximum of 10% of the mortgage balance each year.
Some products allow up to 20% and there are some ‘unlimited overpayment’ products too. Before overpaying it’s always best to check with your lender as overpaying by more than your allowance can incur fees.
Will I have to pay a Penalty if I Overpay on my Mortgage?
Some lenders will charge you a fee if you overpay on your mortgage. However many lenders will allow you to overpay by up to 10% of the mortgage balance every year.
Fees can be steep, sometimes between 1% and 5% of the amount overpaid, but it varies between mortgage deals so always check with your lender before overpaying.
Can you get an Unlimited Overpaying Mortgage?
Yes, most lenders offer a mortgage product with an unlimited overpayment facility.
However it often means that they will give you an unfavourable interest rate or SVR. Considering most lenders will let you overpay 10% and some will go as high as 20% it is worth thinking about if you really need unlimited overpaying.
Some mortgages allow you to overpay and then take the money back if you need it. These flexible mortgage accounts include offset mortgages, current account mortgages and mortgages which have a ‘borrow back’ facility.
Discussing your situation with a mortgage advisor can help you to decide what the best option is for you.
Is it Better to Overpay your Mortgage or Put Money into Savings?
Currently interest rates on saving accounts are so poor that financially it could be better to make savings work harder for you by reducing your mortgage debt and overpaying.
If you’re just looking at the sums, in order to make it worthwhile to keep your money in savings then the rate of interest on your savings account would need to be the same rate or better than you are paying on your mortgage.
This means that if your mortgage interest rate is 1.5% then you’d also need to be getting 1.5% or more on your savings.
Plus if you have already used up your personal savings and ISA allowances then you’d need your savings rate to be even better. For example for a higher-rate taxpayer it would need to be upwards of 5% .
For example: If you have £10,000 and one year left on your mortgage and are paying 2% in interest on it then your annual interest will be costing you £200. However, if you have £10,000 in a savings account which pays interest at 0.5% then you’ll be earning £50 in interest. This means that if you were to use the £10,000 in your savings to overpay on your mortgage you would be £150 better off.
It is important to consider that once you have paid the money from savings into your mortgage you can no longer readily access that money. So if you think you might need the cash in your rainy day fund it might be better to keep it in savings.
Is it Better to Overpay the Mortgage or Reduce the Term?
If your salary or income increases significantly then remortgaging and getting a whole new mortgage deal to reduce the term instead of overpaying might be a good idea.
By remortgaging you could reduce the term of your mortgage which means that you will not only pay it off sooner but you will also pay less in interest, potentially saving you a lot of money in the long term.
Using the same amount of borrowing (£150,000), mortgage term (25 years) and interest rate (2%) as our previous example, remortgaging to reduce the term to 20 years would take the monthly payments from around £635 a month to £759 – effectively ‘overpaying’ by £124 a month and becoming mortgage free five years sooner.
However, this doesn’t account for any fees incurred when remortgaging so often the final calculations are a little more complex.
Can I Overpay on a Buy-to-Let Mortgage or Interest-Only Mortgage?
Yes, many lenders will allow you to overpay on buy-to-let or interest-only mortgages but some will not.
Before committing to overpaying make sure you check the terms and conditions of your individual mortgage deal.
Things to consider before overpaying on your mortgage:
- Do you have other more expensive debts (such as credit card debt) that you should pay off first?
- Will you have to pay penalty fees for overpaying?
- Do you have sufficient readily-available savings in case of emergency? Before sinking all your savings into overpaying on your mortgage it is worth ensuring you have a high-interest savings account with a decent amount of money in it. Some recommend having between 3 and 6 month’s salary in savings.
Here at VA Mortgages we would be happy to discuss your individual circumstances and help you to assess if overpaying on your mortgage is the right option for you.
Fill out the form below for a no obligation discussion about your circumstances: