The benefits of overpaying on your mortgage
MoneySuperMarket figures show that you could reduce the amount you owe on a £100,000 mortgage by almost £10,000 in just three years if you increase your monthly payments by £250 a month (based on an average interest rate of 4.38%).
If the £250 a month were paid into a savings account instead, however, the interest earned over three years at the average rate of 0.45% would be just £313.58. And that’s before tax.
Clare Francis, mortgage expert at MoneySuperMarket, said: “Not only can mortgage borrowers benefit from the lowest mortgage rates in history, they can also reduce the negative impact of low savings rates by channelling spare cash into their mortgages instead.”
Longer term, the benefits are even more marked. For example, overpaying by £250 a month over a 15-year term, for example, would save a staggering £12,242 in interest alone and shave four years and eight months off the mortgage term.
A borrower with 15 years left run on his or her mortgage would therefore be debt-free in just over 10 years, not to mention better off than had they put £250 into a savings account paying a market average rate of 0.45% and earned interest totalling £2,335.65.
If he or she then went on to invest the mortgage payments they would have been making into a savings account – even one paying just 0.45% - they would also end up with a total pot of £57,103.06 by the time the mortgage would have originally ended.
That’s around £10,000 more than the £47,335.56 pot created by doggedly putting £250 into the same account over the whole 15-year term. And, coupled with the interest savings made on the mortgage, that makes overpaying the better option by an incredible £22,010.
Sounds good, doesn’t it? That’s why we have put together this guide to answer all your questions about mortgage overpayments and how they can improve your wealth in the long run.
How can I overpay?
There are two ways to overpay on your mortgage: You can choose to increase your monthly mortgage payments or you can make one-off payments every so often to bring the account balance down.
How you overpay will depend on your individual circumstances. Those who receive a bonus at the end of the year, for example, will often prefer to make a lump sum payment at that time. For others, however, it will be easier to budget to pay a bit more every month.
But if either is possible, James Cotton at mortgage broker London and Country recommends making regular overpayments: “If your mortgage rate is say 3% or 4%, then it makes more sense to increase your monthly payments than to put any extra money you have into a savings account that is unlikely to pay more than about 2%,” he said.
Either way, you should contact your mortgage provider to find out how to make an overpayment – and check whether you will incur any penalties as a result.
How much can I overpay?
If you have enough cash available, you can choose to completely redeem your mortgage at any time. However, many mortgage deals involve penalties known as Early Repayment Charges (ERCs) that kick in if you want to overpay by more than a certain percentage of the loan amount.
Most lenders will allow penalty-free overpayments of up to say 5% or 10% of your mortgage balance each year. On a £100,000 mortgage, this means that you can add an extra £5,000 or £10,000 to your regular payments each year without incurring a penalty, which is sufficient for most people.
Why might I not be able to overpay?
Whether or not you can overpay on your mortgage will depend on the type of deal you are on. HSBC, for example, allows customers with lifetime tracker mortgages to make unlimited overpayments, but imposes ERCs on those on fixed or discounted rate mortgage deals.
Standard Variable Rate (SVR) deals will allow you to overpay as much as you want. Cotton said: “Quite a high proportion of mortgage borrowers are in a position where they are permitted to overpay particularly as so many are currently on SVRs due to the low interest rate environment. These people can overpay as much as they want without incurring charges, but that is not the case for most people on short-term, low-rate deals”
What penalties could I face?
Average ERCs are set at between 2% and 3% of your mortgage balance – or in other words, the total amount you owe. But the type of deal you are on can affect how much you pay. Santander, for example charges a standard 3% in ERCs but 5% if you are on a five-year fix.
The length of time you have had the mortgage for can also affect ERC levels. “Often, ERCs are on a sliding scale,” explains James Cotton. “Someone on a five-year fix might therefore face penalties of 6% to redeem the mortgage in the first year, falling to 1% in the fifth year of the deal.” These are often known as 'tiered' redemption penalties.
You will have to pay the ERCs at the same time if you pay off your mortgage completely, while those making say a 20% overpayment will generally have the penalties incurred as a result added to the balance on their next mortgage statement.
What happens to the money?
Most mortgage deals now charge interest monthly, so the benefit of an overpayment should be pretty immediate – usually showing up on your next statement. Borrowers with offset mortgages, however, will see their mortgage balance go down if they add money to the linked savings account – the difference being that they retain access to those funds.
Can I ever get the money back?
As explained above, taking out an offset mortgage is probably the best way of retaining access to your savings while using them to reduce the interest you pay on your mortgage.
Some mortgage lenders, such as Virgin Money, also allow those on fully flexible deals to borrow back overpaid amounts, subject to a credit check.
Nationwide, meanwhile, allows customers who overpay to build up an overpayment ‘reserve’, which you can use to either reduce your monthly payments by a set amount – say £50 a month – or stop making payments for a set period if necessary.
Whatever position you are in with your mortgage, it always makes sense to be on the best deal. Shop around at our mortgage channel.
Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct