Should you overpay on your mortgage? The pros and cons
By overpaying on your mortgage, you could reduce your debt and save money. But should you? Read more about the pros & cons of overpaying your mortgage here.
At the time of writing, the Bank of England base rate is currently 3.75%, so you can get a good savings rate by shopping around.
But with average mortgage rates sitting between 5% and 6%, it might be worth overpaying on your mortgage instead.
By overpaying on your mortgage, you could reduce your debt and save money that way.
You'd be making gains at the same rate as your mortgage.
So, if your mortgage rate is 6%, for example, that's the equivalent of savings that would earn 6% in interest.
It sounds like a win-win – but is it always the savvy move?
We look into the benefits and disadvantages of overpaying on your mortgage below.
The main plus-side of paying off more of your mortgage is that you’ll reduce your debt and bring yourself a step closer to being mortgage free.
Overpaying your mortgage could help you cut your loan-to-value (LTV).
Most fixed-rate mortgages come with an initial tie-in period, during which you can’t leave the deal without being penalised by a fee.
To ensure you make the most informed choice for your financial future, it is highly recommended to seek professional guidance.
What is a mortgage overpayment?
A mortgage overpayment is any amount you pay towards your mortgage that is over and above your standard monthly repayment.
These extra funds are typically applied directly to the outstanding capital of your loan.
By reducing the total capital owed, you can decrease the amount of interest you’ll pay over the full term of the mortgage and become mortgage-free sooner.
Should I overpay or reduce the mortgage term?
When you are in a position to pay more towards your mortgage, you generally have two options:
Making overpayments
Reducing your mortgage term
While both strategies will help you pay off your loan sooner and save on interest, they work in different ways.
Making overpayments offers flexibility.
You can choose to pay extra whenever you have spare funds, either as a lump sum or through regular additional payments.
This approach allows you to revert to your standard monthly payment if your financial circumstances change.
Formally reducing the mortgage term is a more rigid commitment.
You agree with your lender to shorten the life of the loan, which results in a higher, recalculated mandatory monthly payment.
This guarantees you will be debt-free by the new, earlier date but removes the flexibility to reduce your payments if you need to.
Ultimately, the best choice depends on your financial discipline and stability.
If you value flexibility and want the ability to adjust your payments, making overpayments is likely the better option.
If you prefer a structured plan and are confident you can meet the higher payments for the remainder of the loan, then formally shortening the term could be the right path for you.
Benefits of overpaying on your mortgage
Cut your debt AND your interest
The most obvious plus-side of paying off more of your mortgage is that you’ll reduce your debt and bring yourself one step closer to living mortgage-free.
Learn more: should I pay off my mortgage or invest?
Perhaps what is less obvious is that you’ll bring down the amount of interest you pay, too.
Say you have £150,000 left of a 20-year mortgage with a 6% rate.
If you overpay a lump sum of £15,000 (that’s 10%), you will pay off your mortgage two years and seven months early. Plus, you’d save £29,600 in interest.
Saving money by overpaying on your mortgage
You may be able to save some money by overpaying your mortgage compared to what you would get in interest from a savings account.
Let’s say you keep the £15,000 cash in an easy access savings account paying 4% interest. You’d earn £600 on it a year.
That makes the £29,600 in saved interest from overpaying the mortgage even more appealing.
You could access better mortgage deals
Overpaying your mortgage could help you cut your loan-to-value (LTV).
This is the proportion of your property price covered by your mortgage.
It goes down if your property value goes up and as you pay off more of your mortgage. That’s why overpaying can help bring it down.
A good reason to bring down your LTV is that lenders use this figure to decide which deals they’ll offer you.
The lower your LTV, the lower the interest rates you can access.
So overpaying on your mortgage could mean that you get an even cheaper deal when you come to remortgage.
Disadvantages of overpaying on your mortgage
You may be hit with fees
Most fixed-rate mortgages come with an initial tie-in period, during which you can’t leave the deal without being penalised by a fee.
The same applies to if you overpay on your mortgage, meaning you could be ‘fined’.
These are called Early Repayment Charges (ERC), and they’re usually between 1% and 5% of the balance.
If you’ve got a £150,000 mortgage, even 1% will sting you with a £1,500 ERC.
However, if you’ve got a £50,000 mortgage, 1% would only leave a £500 dent in your pocket, which may be worth it if you could cut down the balance and the interest by a significant amount.
There is also usually some leeway. Most lenders will let you overpay by around 10% a year during the tie-in period, which you can do in chunks or monthly overpayments.
Don’t just take our word for it, though. Check your mortgage details before you overpay.
You’ll lose access to the cash
Wiping off your mortgage debt may be a big ambition, but it’s important that you always have some emergency cash available.
If the pandemic has shown us anything, it’s that you really can’t know what’s around the corner.
Generally, it’s a good idea to have three to six months’ pay (after tax) at hand, but ideally 12 months’ pay.
You could need it for all sorts of reasons, from unexpected house repairs to covering your living costs if you suddenly can’t work for any reason.
However, this doesn’t necessarily apply if you have a flexible mortgage, like an offset or current account one.
These give you the option to borrow back money you’ve paid off, so you won’t be strapped for cash if you overpay.
Alternative options to overpaying on your mortgage
There are other ways you could get around the current meagre interest rates.
Take advantage of better savings rates
You can get easy access rates of over 4% and even higher if you opt for a fixed-rate account (although you won’t be able to access your money in this scenario).
Pay off more expensive debt
Your mortgage may be the biggest debt you have, but it might have a lower interest rate than other debts.
Credit cards, unsecured loans and overdrafts can be much more expensive, and it’s generally advised to pay these off first.
Top up pension pot
If you have spare cash, putting it into your pension pot could be sensible as you’ll get tax relief on it, and it will be invested to help it grow.
There’s no limit on how much you can pay into your pension, but only up to 100% of your salary or £60,000 attracts tax relief.
Find out if you're saving enough for retirement with the Unbiased pension calculator:
Get expert mortgage advice
Deciding whether to overpay on your mortgage, put your money into savings, or invest it elsewhere is a significant financial decision with no one-size-fits-all answer.
The best path depends on your individual circumstances, including your mortgage rate, your attitude to risk, and your long-term goals.
To ensure you make the most informed choice for your financial future, it is highly recommended to seek professional guidance.
Unbiased can connect you with a qualified mortgage or financial adviser who can provide personalised advice tailored to your unique situation, helping you to move forward with confidence.
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