Mortgage overpayments - what you need to know

Mortgage overpayments might sound like you are paying more than you actually owe. But it’s quite the opposite! It’s a great way of reducing the time it takes to pay off your loan.

And that means by paying a little more each month you actually save money in the long run!

Whether you can take advantage of mortgage overpayments depends on a number of factors. The main one is whether you have the extra cash to make those payments!

We’ll look at the other points you need to know here. And if at any time you want to see how much you could save by paying extra on your mortgage, you can use our handy Overpayment Calculator.

Let’s take a deep dive into what you need to know about mortgage overpayments.

What are mortgage overpayments?

When you take out a mortgage, you know you will have anywhere between 25 to 35 years to pay off your home loan. That’s pretty much a lifetime commitment!

Not everyone relishes the idea of paying off a mortgage forever. In fact, a recent study by TSB Bank reveals 67% of first-time buyers are making mortgage overpayments. The same survey says that’s because one in six first-time buyers want to pay off their mortgage by the time they’re 40!

Mortgage overpayments work by paying off a little more than your agreed, standard monthly payments. Those extra payments then reduce the capital you owe. That means the amount you borrowed. And as you will increase your equity, you’ll own a bigger share of the property more quickly. As a result, it should also reduce the interest you owe in the long run.

How to overpay

There are two ways you can overpay your mortgage. You can:

• Make regular overpayments. For example, you may have a job that pays more than the one you had when you originally took out your mortgage. That means you might have more cash spare each month. You could spend that on making overpayments every month to reduce what you owe.

• Or you could make one-off lump sums. If you inherit money, are given a bonus at work or want to use some savings, you can pay an extra one-off amount as a lump sum.

In all cases, there are likely to be limits as to how much you are allowed to overpay before your payment attracts penalties. You will need to check with your mortgage lender to see what that is.

Why should I make overpayments?

Mortgages are probably the biggest debt most people will owe. And that debt accrues interest on a daily basis. If you reduce the capital you owe, you will make savings in the long run.

Here’s an example of how it can help.

Let’s say you take out a mortgage of £200,000 over 25 years. If your monthly repayment is £1,170, you could save £17,000 in interest by making overpayments of £100 a month. And doing that would mean you would be mortgage free 4 years earlier than if you only make standard payments!

Being able to make larger overpayments would lead to even bigger savings.

When overpayments don’t make sense

While those figures are impressive, there are reasons why you need to think before making mortgage overpayments. The main drawback of overpayments are early repayment charges. They’re effectively a penalty for paying early as the lender’s original deal was made on the data you gave them.

Most fixed-rate mortgages only allow overpayments of up to 10% before the early repayment charge kicks in. And that can sometimes be in the thousands! You should check with your mortgage lender before making big overpayments.

Also, once you have spent your funds on making mortgage overpayments, those pounds and pence will no longer be available to you. That sounds obvious, but if you suddenly have big bills you might leave yourself short. For example, if an unexpected car repair or emergency means you need extra funds, you won’t have the cash once you’ve overpaid on your mortgage. Try and keep three to six months of savings for unexpected expenses before you decide to make overpayments.

If you do have extra funds, it might be better to pay off other debts. For example, if you have a credit card, paying that off more quickly should be a priority. That’s because the interest will be so much higher.

And while interest rates on savings might be low, there could be limited access savings accounts that offer a better return on your money than paying off a mortgage.

Reduce the term or payment?

If you decide to make mortgage overpayments, the next time you remortgage the lender will make two offers. They will either suggest…

• Reducing future standard monthly payments, or

• Shortening your mortgage term

What option you take depends on your plans. If it’s to save the interest you owe, reducing the term will be best.

But if you were hoping to reduce your monthly payments, then the first option is for you. Remember, however, that you won’t save as much in the long run.

What should I do?

Mortgage overpayments are a great way of saving money over time. Even small overpayments can transform your long-term finances. But it’s best not to jump in without checking all the terms of your current mortgage.

You can speak to our team for advice. And don’t forget to use our free Overpayment Calculator to see how overpayments could look for you.

Remember that your home may be repossessed if you do not keep up your repayments on your mortgage.