What is a mortgage overpayment?
A mortgage overpayment is paying more than your monthly mortgage repayment. This can be done as a lump sum payment or an increase to your monthly payments. Though this can save you money in the long term, there are usually restrictions on the amount you can repay each year.
Most providers allow mortgage overpayments of up to 10% of the total mortgage value per year at no extra cost. However, it's important to check the exact amount you can repay each year and whether there are any associated costs.
If you go over the set amount that your provider allows you to repay, then you will have to pay an early repayment fee. This is normally charged as a percentage on the amount you have paid over the threshold.
How much could you save?
To calculate your potential savings from mortgage overpayments, first determine how much you'd save by shortening your mortgage term and paying less in interest. Then, compare this to the interest you would earn on your savings.
For example, if you have £10,000 in mortgage debt that you want to clear and the interest on that debt for the next year is 5%, you would have £500 to pay off in interest. You would then compare this amount to potential gains in interest, so if you had £15,000 in your savings account and an interest rate of 2% then you would accrue £300. In this scenario, by making mortgage overpayments instead of leaving your money in a savings account, you would save £200.
Before making any payments, ensure that your overpayments don't exceed the threshold set by your provider. If you go over, the early repayment fees may outweigh any potential savings.
Another advantage of mortgage overpayments is that they can give you more flexibility in the long term, allowing you to underpay in the future. For example, if you pay three months’ worth of monthly payments in a lump sum then you may then be able to skip your monthly payments for the next three months. Always check the terms of your agreement before deciding to do this.
Are there risks in overpaying?
Before you begin overpaying, double-check your finances and ensure you’ll still have enough savings in the bank to cover unexpected emergencies, such as losing your job or needing to pay for a repair on your home.— Liz Hunter, Commercial Director at Money Expert
When deciding whether to make mortgage overpayments, it’s important to consider the potential risks.
One risk is that once you’ve made overpayments, most lenders won’t allow you to get that money back, unlike if you had left it in your savings account. It’s important to only consider paying extra on your mortgage if you will still have enough in your savings account in case of a financial emergency.
Another factor to consider is the timing of your overpayment. While most mortgage providers calculate the interest you owe daily, meaning you would benefit immediately from a mortgage overpayment, others don’t. If your interest rate is calculated annually you should check when the date this is set. For example, if your interest rate is set in April but you make your overpayment in July, your extra payment won't affect your mortgage balance or interest rate for a year. Therefore, it makes sense to time your repayment to be closest to the date the interest rate is set.
Before making mortgage overpayments, it’s also important to ensure you don’t have other outstanding debts with a higher interest rate than your mortgage. If you do, your priority should always be clearing the debts with higher interest as this will be costing you more than any potential savings from mortgage repayments.
How to make a mortgage overpayment
Once you’ve decided you want to make a mortgage payment, it’s best to speak to your lender and go over the limits and fees set by your agreement before you pay. Once you’ve made your first overpayment, you can set up a recurring overpayment via standing order or bank transfer. Some mortgage providers may give you the option to use the extra money to reduce your mortgage payments, saving you money on interest by shortening your mortgage term while keeping your payments the same, or to reduce your monthly mortgage payments.