If you can overpay on your mortgage – i.e., pay more per month than normal – you can clear your debt quicker and ultimately save thousands of pounds in interest payments.
You can overpay on a mortgage in a variety of ways, but usually it will either be in the form of a one-off lump sum – such as from an inheritance or bonus – or via smaller regular overpayments. You can also overpay your mortgage by making ad hoc overpayments as and when you have some spare cash.
Before you overpay on your mortgage you need to decide whether paying off your mortgage is a good idea. If you have extra money you may be better off using it elsewhere.
Some lenders charge an early redemption fee, we explain how this works this later
If you have a mortgage, your lender will calculate your monthly repayments based on:
The amount borrowed
The term of the mortgage
The interest rate
A mortgage overpayment is the simple act of paying more than the amount specified by the lender.
This could be a lump sum from a bonus at work or an inheritance. Or if your financial situation changes and you have some spare money each month, you might choose to increase your mortgage repayments by say £100 or £200 per month.
If your salary or income increases you may be better off switching your mortgage, in effect remortgaging it completely. You may be able to get a better interest rate and pay it off sooner.
By paying off your mortgage sooner, you will reduce the amount of interest that you pay. The total savings on a large mortgage could be tens of thousands of pounds.
The best way to illustrate the possible savings is with an example.
If you have a £300,000 mortgage at 2.5% over 25 years, the normal monthly repayment would be £1,346.
If you stick to that repayment schedule, you will pay the lender £403,806 in total after 25 years.
If you overpay by £200 per month, you would be mortgage free four years sooner and pay about £20,000 less
If you overpay by a single lump sum of £20,000, your mortgage would be about two years shorter and you’d pay about £15,000 less overall
To find out how much you could save, simply use a home loan overpayment calculator to show the difference between how much you would pay overall, with and without the mortgage overpayment you are considering.
The simple question you need to answer is: if you have some spare money, is mortgage overpayment the most sensible thing you can do with it?
You have large debts that charge a higher rate of interest than your mortgage
You have a personal or workplace pension – some pension funds are growing faster (paying more interest) than mortgage rates (and you can access your pension at 55)
You have access to a savings account which pays more interest that your mortgage
Usually, it’s a case of comparing the interest rate of any loans you might have versus the interest on your savings – but it can be a little more complex than that.
If your mortgage is your only debt, using a mortgage overpayment calculator can help you work out how overpayment will affect the overall cost of the loan.
Putting your money into a pension may not sound like a good idea, but you get tax relief on the money you put in, and you can withdraw it when you are 55.
If your pension grows faster than your mortgage interest, you may be better keeping it in pensions savings and using the money you make to pay off any mortgage at 55.
Always take advice if you are thinking of putting more money into your pension, find out more via The Pensions Advisory service
If you can find a savings account with a higher rate of interest than your mortgage, then putting the money into your savings may be a better solution. Just make sure you research your savings account options first.
If, on the other hand, you have non-mortgage debts like credit cards, overdrafts, or a loan – all of which generally have high interest rates – then paying them off will probably give you a better return on your money.
But if you’re looking to remortgage your home – to get a better interest rate, or borrow more money for home improvements – then overpaying on your mortgage can help you reduce your loan-to-value (LTV) and access the best mortgage rates.
Lenders generally reserve the best mortgage rates for borrowers with the lowest LTVs – so if you can reach an LTV of 60%, there are some great deals to be had.
Whether and by how much you should overpay on your mortgage will also depend on the type of deal you have in place.
If you have a flexible mortgage, such as an offset mortgage, you can freely overpay and then access your funds later if you need them for some reason. But if you are on a fixed rate or variable rate deal lasting say two or five years, there may well be limits on how much you can overpay before facing charges.
Offset mortgages were pioneered by The Woolwich (now part of Barclays) and allow borrowers to offset their savings rate in order to pay less off their mortgage.
Before you make a mortgage overpayment, double check that you won’t fall foul of any charges.
Some mortgages allow for unlimited overpayments – but others, particularly fixed-rate mortgages, will charge you a fee if you overpay more than a certain amount.
The fees - known as early redemption charges or penalties - and overpayment thresholds can vary widely between lenders and products, so be sure to read the small print of your mortgage. Or just phone up your lender and ask.
Generally speaking, you should contact your mortgage lender before you start making overpayments, to let it know you’re trying to reduce the term of the mortgage.
Your lender may then give you the option of setting up a new direct debit with the overpayment included. Or instruct you to transfer a lump sum from your bank account to the mortgage account.
You may even be able to add your mortgage account as a payee within your mobile banking app and then send overpayments whenever you feel like it.