If you can overpay on your mortgage – i.e. you can 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 (from an inheritance, perhaps), smaller regular overpayments, or ad hoc overpayments as and when you have some spare cash.
There is one big decision to make before you overpay on your mortgage: if you have some spare money, where is the best place to put that money to maximise your returns? Overpaying your mortgage is one option, but could you make more money by putting your cash into a savings account? Or do you have other debts that you’re paying a lot of interest on? 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.
How do mortgage overpayments work?
If you have a mortgage, your lender will calculate your monthly repayments based on: the amount borrowed; the term of the mortgage; and 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 £100 per month.
The net result is the same: 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.
Mortgage overpayment example
The best way to illustrate the possible savings is by way of 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 would 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.
Should you overpay your mortgage?
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?
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 – but make sure you research your savings account options first.
If 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.
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.
And finally, if you’re looking to remortgage your home – to get a better interest rate, or borrow more money for home improvements – then overpaying your mortgage can reduce your loan-to-value (LTV). Usually, lenders will reserve the best interest rates for borrowers with the lowest LTVs – if you can reach an LTV of 80%, there are some great deals to be had.
Now read: What mortgage can you afford?
Watch out for early repayment and overpayment charges
Before you make a mortgage overpayment, double check that you won’t run afoul of any charges for overpayment of your mortgage
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 fee and overpayment threshold can vary between lenders and products, so be sure to read the small print of your mortgage – or just phone up your lender and ask.
How to make mortgage overpayments
Generally, you should contact your mortgage lender before you start making overpayments, to let them know that you’re trying to reduce the term of the mortgage.
Your lender may give you the option of setting up a new direct debit with the overpayment included, or you might simply be instructed to transfer a lump sum from your bank account to the mortgage account. You can even add your mortgage account as a payee within your mobile banking app and send then send overpayments whenever you feel like it.
Now read: Four ways to pay off your mortgage early