When you sign up for your mortgage deal, you agree to pay your lender back a certain amount of money for the duration of that deal.
Overpaying a mortgage just means that you’re paying back more than the agreed amount in a particular month or year. Usually, people do it to pay off their mortgage sooner and become mortgage free faster.
Let’s say your agreed mortgage payments are £500 a month. You could overpay by:
- Upping those payments to £600 a month (a regular overpayment of £100), and/or
- Making an extra one-off payment, for example, of £5,000.
You might consider overpaying your mortgage if you’ve saved some extra money and you want to use it to clear your mortgage debt more quickly. Or, if you get bonuses at work, or some inheritance, you might want to put it towards your mortgage.
Be aware that most lenders only let you overpay by up to 10% a year while you’re still in your fixed period – more on that later.
So what are the advantages of overpaying a mortgage? And what should you think about before diving in? Let’s find out.
What are the benefits of overpaying a mortgage?
Overpaying your mortgage has the potential to help you:
- Become mortgage-free faster
- Save money on interest payments
- Open up options for remortgaging
Let’s unpack these three benefits in a bit more detail.
Become mortgage-free faster
If you’re chasing a mortgage-free future, overpaying on your mortgage can help you repay your debt in less time.
For example, let’s say that you have a £150,000 mortgage that you’re paying over 25 years, based on monthly repayments of £630. If you overpay by £100 a month (£1,200 extra over the course of each year), you would pay off your mortgage around 4 years early. Amazing!
Before you start overpaying, get in touch with your lender and let them know that’s what you’ll be doing. Make sure you explain that you want your overpayments to reduce the term of your mortgage. Otherwise, they may simply reduce your next monthly mortgage repayment by the amount you overpaid, which won’t help you repay your mortgage more quickly in the end.
Save money on interest payments
Each month you’ll be paying interest on your mortgage, worked out as a percentage of the value of your remaining debt. Overpaying your mortgage means there’s a smaller amount of debt to pay interest on, leading to lower interest payments.
This means that, with interest rates on most savings accounts currently at rock bottom, overpaying your mortgage can often be a better investment.
Let’s say you came into a £20,000 inheritance, and you were trying to decide whether to use it to pay off your mortgage, or put it in a savings account:
- £20,000 of mortgage debt at 2% interest a year would cost you £400 a year.
- In a savings account at 1% interest, that £20,000 would earn you £200 a year.
So in this example, paying off your mortgage debt means you’re £200 better off each year than keeping that money in a savings account.
Open up options for remortgaging
Overpaying your mortgage can help you reduce your loan to value (LTV) – that’s the amount you’ve borrowed compared to your home’s current value. The lower your LTV, the lower the interest rates lenders will offer you when it’s time to remortgage (switch your mortgage deal).
That’s because lenders see low LTVs as a lower risk (they’re confident they’ll get their money back from you) and so they’re willing to offer you lower interest rates and more flexible deals.
So, shorter mortgage term, less interest to pay, better mortgage deals available – it all sounds great.
But overpaying a mortgage isn’t the right step for everyone. Try asking yourself these 4 questions before making the leap.
4 things to consider before overpaying your mortgage
- Do you have more urgent debts to pay?
If you have any other loans with a higher rate of interest than your mortgage, it’s best to prioritise paying these off. This includes things like credit cards and overdrafts. Clearing these debts will help prevent the interest charges piling up and save you cash in the long run.
- Do you have an emergency fund?
If you put all your savings into overpaying your mortgage, they won’t be easy to access anymore. It’s handy – if you can – to have some money set aside for emergencies – like if you lose your job or your roof needs replacing. The general rule is to save 6 months’ after-tax pay, if you can. Having this pot to draw on could stop you getting into more debt later on.
On the other hand, if you have a flexible mortgage (such as an offset mortgage) where you can overpay and borrow the money back without having to pay a fee, having a separate savings pot is less crucial. The interest rates tend to be quite high with these mortgages though.
- What are your lender’s rules and fees for overpayment?
Check how much you’re allowed to overpay in the terms of your mortgage agreement. Your lender might charge you a fee if you pay too much, which is called an early repayment charge (ERC). That’s because if you pay off your mortgage early, your lender loses out on the interest they’d otherwise have charged you over the years.
Most lenders will let you overpay up to 10% of your mortgage balance a year, without a penalty, while you’re still in the discount or fixed rate period of your mortgage deal (when you’re typically paying less interest). If you had £250,000 left to pay on your mortgage, that would mean you’d be allowed to overpay up to £25,000 a year without being charged extra.
The early repayment charge is usually 1-5% of the remaining balance on your mortgage, or on the amount you overpay beyond what your lender allows. So let’s say your lender lets you pay off an extra 10% without ERCs (£25,000 a year) but you pay £35,000, they may charge you 5% on that extra £10,000 – which is £500.
Sidenote that as well as charging you an ERC for paying off too much of your mortgage, your lender may also charge you if you try to leave your fixed deal before it ends. For example, if you have a £250,000 mortgage with a 5% ERC, but you want to switch mortgage providers and move away from that deal, you might need to pay £12,500 in fees – 5% of £250,000.
At Habito we offer a fixed rate mortgage that lets you overpay as much as you want, without any penalties, called Habito One.
Many variable rate mortgages let you overpay as much as you want – but interest rates are higher. If you’re on a variable rate, you might save more by remortgaging instead of overpaying.
You can also wait until you hit your lender’s standard variable rate (SVR) after your fixed term ends, and make a lump-sum overpayment before switching to another mortgage deal. If your lender’s SVR doesn’t include any early repayment charges, it might make financial sense for you to do it this way.
- Could you save more money with a savings account?
Although savings accounts that pay decent interest are hard to come by these days, it might still be worth shopping around. If your mortgage interest rate is already quite low, it’s just possible that you could find a savings account which will earn you more interest than you could save by overpaying.
Is it worth overpaying your mortgage?
If you’re confident that overpaying on your mortgage is the right way forward, let’s look at a couple of examples of what you could save.
Below, we’re calculating the sums based on you having a £250,000 mortgage that’s repayable over 25 years at an interest rate of 2%. Bear in mind your situation might be different in real life.
Overpayment with a lump sum
If you make an overpayment with a one-off lump sum of £10,000, you’ll pay off your mortgage about a year early and save around £6,000 in interest.
If you make regular overpayments of £200 a month (totalling £2,400 a year), you’ll pay off your mortgage almost 5 years early and save about £14,000 in interest over the period you’re paying your mortgage.
If your mortgage deal allows you to overpay up to 10% of your remaining balance a year without ERC fees, neither of these overpayment examples would cause any extra costs for you (because 10% of £250,000 would give you a limit of £25,000 a year in overpayments).
And you might also want to consider waiting until your lender moves you onto their SVR after your fixed term begins, because that may allow you to make a lump sum overpayment without incurring ERCs. It all depends on how costly it is to be temporarily on your lender’s SVR.
How to overpay a mortgage
Happy to take the next step and make an overpayment on your mortgage? Here’s what to do:
- Get in touch with your lender. Ask what their rules are about overpaying, so you can be sure you won’t get landed with a fee for overpaying too much.
- Be clear what you want. When arranging the overpayment, be clear that you want it to reduce the term of your mortgage (so you can pay off your debt sooner).
You don’t want the overpayment to simply reduce the next month’s payment – that would save you a little bit of interest (because you paid early) but not as much as reducing the term of your mortgage will.
- Set up the payment. Usually, you can make your overpayment using online banking. Just set up your mortgage account as a new payee. Then you can either make a one-off overpayment or set a standing order to overpay a certain amount monthly. Alternatively, your lender might agree to take a higher amount in their monthly direct debit.
And that’s it!