The thought of paying more than the minimum amount you are obligated to pay each month on your mortgage may sound foolish at first. But, upon further investigation, overpaying your mortgage can sometimes make good financial sense. There are a few things to consider first before deciding if this is the right thing for you to do.
Many people aren’t aware that they may be able to overpay on their mortgage and that doing this might prove beneficial to them in the long run. Any additional payments you make, over and above the minimum monthly repayments set by your mortgage lender, will go towards paying off the outstanding mortgage balance you have owing. This will not only reduce your outstanding debt, but will also help to reduce the total amount of interest you pay across the life of your borrowing, and will also reduce the length of time it takes you to fully repay your mortgage loan, getting you mortgage-free sooner.
There is, however, quite a bit to consider before going down this route – particularly as not every lender will allow you to make overpayments, and some may even charge you for doing so. Most lenders do allow some overpayment on their mortgages, but some set a cap on the amount and frequency that you can do this, so it is important to know what your current or proposed mortgage deal will allow.
What is a mortgage overpayment?
When you take out a mortgage, your lender will calculate the minimum monthly repayments needed from you to ensure that your mortgage loan will be fully paid off at the end of the agreed term. This calculation is based on the interest rate at the time, the agreed term of the loan, and the amount that you borrow. Any changes in interest rate during the term of the borrowing will change the amount of the repayments required, hence you will sometimes get advice from your mortgage lender that your monthly repayments need to be increased or reduced if the national ‘base rate’ of interest changes.
A mortgage overpayment is simply paying more towards your mortgage than the monthly payment amount set by your lender. Overpayments can be made as a one-off lump sum, perhaps from an inheritance, windfall, or bonus, or you can set up regular overpayments by choosing to increase your monthly payments. You need to ensure that you don’t exceed your limit.
So, why might you overpay on your mortgage? One reason for overpaying your mortgage might be that you want to pay off your mortgage early. Or by making overpayments it will allow you to reduce down your mortgage balance and as a result of you reducing your mortgage balance, you should be able to access a better loan-to-value rate.
A lender will issue different interest rates depending on your loan to value, the more equity you have in your home (the value of your house versus the amount you owe the lender). Generally the better mortgage rates you’ll have access to, the loan to value thresholds are set at every 5%, so someone who has 20% equity will have better rates than someone at 10%.
Some lenders will place restrictions or limits on any overpayments – and some simply don’t allow them at all. It’s important to check, therefore, what your mortgage terms and conditions are before making any overpayments. You could incur £1000’s in fees that could easily have been avoided.
Why do some lenders limit overpayments?
Whether or not you can make overpayments will depend on your lender and the type of mortgage deal that you are on. Most mortgage lenders impose restrictions limiting overpayments during any initial introductory fixed, tracker, or discount rate periods. They usually limit any overpayment during this period to a maximum of 10% of the mortgage balance in any one financial year.
If you are beyond your introductory fixed deal, however, and have moved onto the lender’s standard variable rate (SVR), then you usually can overpay by as much as you like. That being said, many SVRs are more expensive than other rates available on the market, so you might save yourself more money by remortgaging onto a better deal, rather than overpaying.
If you are looking to get your mortgage repaid quicker, then you can always look to remortgage your borrowing for a shorter loan term than you currently have, providing you are entirely confident you can afford the higher monthly repayments that will be needed. This will get you mortgage-free sooner and reduce the total amount you pay in interest throughout the life of your mortgage.
Some lenders discourage overpaying completely and will charge you an early repayment charge if you try and do so. Fees are typically between 1% and 5% of the amount overpaid, depending on your mortgage. The reason why some lenders do this is because they have budgeted to earn a certain amount of interest from you during the mortgage deal. When you overpay, they receive less interest, making your mortgage less attractive to them.
Should I overpay on my mortgage if I have the opportunity?
If you decide to overpay on your mortgage, it needs to make sense financially. It’s not the right option for everybody, so you’ll need to consider a few different factors before you make the decision. The first thing you need to consider is whether you are better off simply putting this extra money into savings. If you can get a higher rate on your savings than you pay on your mortgage, then savings is the more sensible option. If your mortgage rate is more than your savings rate, then it might make financial sense to make overpayments.
If you have other non-mortgage debts that you can pay off first, then you are usually better advised to use your money to clear these first before considering overpaying your mortgage. This is because credit cards, loans, and overdrafts tend to have much higher interest rates than mortgages. You really should also consider keeping some extra cash saved in an emergency fund (generally around 3-6 months salary or monthly bills is recommended) to cover you if you should lose your job for any reason. What if your car breaks down or your boiler breaks? Having an easily accessible fund to turn to can be a lifesaver.
If you recently enjoyed a pay rise, then before you consider using the extra monthly income to overpay on your mortgage, look at your saving options first. Remember, any money that you use to pay down your mortgage can not be re-accessed. Once you have made the payment, then it is invested and tied up in your property.
Still wondering if mortgage overpayments are right for you? Speak to us at Mortgage Light first. We will assess your situation and your mortgage to ensure that it is going to be worthwhile for your circumstances and that you won’t get hit with any unwanted fees or penalties. Our expert team are well-versed in handling mortgage overpayments, so we’ll make sure that we help you do this in the most effective way. Get in touch with us today and let us help your mortgage work for you.