If you find yourself with some extra money, then overpaying on your mortgage payments could be a potential path to clearing your debt quicker. Overpayments can shorten your mortgage term and save thousands of pounds in interest. Before doing this, there are a few things you may need to consider to decide if this is the right decision for you. Our guide will run through the basics of mortgage overpayments and how they may be beneficial for you.
In This Guide:
- What is a mortgage overpayment?
- How much could you save?
- Are there risks in overpaying?
- How to make a mortgage overpayment
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 will allow you to make mortgage overpayments by up to 10% of the total value of the mortgage per year at no extra cost, but it’s important for you to check how much you can pay back each year and if there are any costs associated.
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 by making mortgage overpayments you need to work out how much you would save by having a shorter mortgage term, and therefore paying less in interest, and compare it to how much interest you would accrue 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. Therefore, in this scenario, by choosing to make mortgage overpayments instead of leaving your money in the savings account you would save £200.
Prior to making any payments it’s important to make sure your overpayments would not go over your threshold for making mortgage overpayments as agreed with your provider as the early repayment fees may cost more than any potential savings.
Another potential advantage of making mortgage overpayments is that it would allow you to have more flexibility with your agreement in the long term as it may allow 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. As always, it’s important to check the terms of your agreement before deciding to do this.
Are there risks in overpaying?
When deciding whether to make mortgage overpayments it’s important to consider the potential risks.
One of those is that once you have made the overpayments most lenders will not allow you to get that money back, unlike if you had just left the money 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 here is the timing of your overpayment. Whilst most mortgage providers will calculate the interest you owe daily, meaning you would benefit immediately when you make 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 wont effect your mortgage balance or interest rate for a year. Therefore, it makes most sense to time your repayment so it’s closest to the date that the interest rate is set.
Before making mortgage overpayments it’s also important to make sure you don’t have other outstanding debts which have 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 run through the limits and fees set by your agreement before you pay them. 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 of whether you want the extra money to be used to reduce your mortgage payments, saving you money on interest by shortening your mortgage term but keeping your payments the same, or reducing your monthly mortgage payments.