You will have seen mortgages mentioned a lot in the news lately. The current cost of living crisis and rise in interest rates are having a large impact on the finances of homeowners. Many of us are facing higher rates when it’s time to remortgage, meaning we have less spare cash at the end of the month.
When it comes to managing our finances, the choices we make can have a significant impact on our financial future. One decision that often leaves homeowners scratching their heads is whether to make mortgage overpayments. The idea of paying off your mortgage sooner and reducing the overall interest you pay is tempting. However, is it always the right move?
I’ve been thinking about this topic a lot lately as we are due to remortgage in less than a year and will lose our current low-interest rate.
So let’s learn a bit more about mortgage overpayments, exploring the benefits, potential pitfalls, and alternatives. After reading this blog post, you’ll be better equipped to make an informed decision that suits your particular financial circumstances.
- What are Mortgage Overpayments?
- The Appeal of Mortgage Overpayments
- Potential Downsides of Mortgage Overpayments
- Overpaying vs. Saving: Which is Better?
- Overpaying vs. Paying Off Other Debts
- Other Alternatives to Mortgage Overpayments
- Making the Decision: Is Overpaying Right for You?
- Why I Overpay My Mortgage
Please note that this post is for informational purposes only. Please speak to an independent financial advisor or your mortgage advisor before making financial decisions.
What are Mortgage Overpayments?
Mortgage overpayments are when you pay more than the amount you’re required to pay by your mortgage lender each month. This extra payment reduces your outstanding mortgage balance, enabling you to own your home outright sooner than originally planned.
In essence, mortgage overpayments are a way of accelerating your mortgage repayment process. They can be made in two ways:
- Regular monthly overpayments: This involves increasing your monthly repayments by a set amount.
- Lump-sum overpayments: This involves making a significant one-off payment.
The Appeal of Mortgage Overpayments
There are several reasons why homeowners might consider making extra mortgage repayments. Here are a few key benefits:
Pay Off Your Mortgage Sooner
The most obvious advantage of making mortgage overpayments is that you can pay off your mortgage debt sooner. By overpaying on your mortgage, you reduce the principal balance, which in turn reduces the total amount of interest you pay over the life of the loan.
Save on Interest Payments
With a repayment mortgage, your monthly repayments are split between paying off the interest accrued and reducing the mortgage balance. The larger your mortgage balance, the more interest you’ll be charged. By making overpayments, you can decrease your mortgage balance and subsequently pay less interest over the term of the loan.
The idea of being mortgage-free is a dream many of us have. Without the burden of a large monthly mortgage payment, you might have more disposable income to spend on other things, such as holidays, home improvements, or even putting money into a savings account or pension. The best way to become mortgage-free is to make regular payments on your mortgage.
Potential Downsides of Mortgage Overpayments
While making mortgage overpayments can have its advantages, it’s also important to consider the potential downsides:
Early Repayment Charges
Some mortgage lenders impose an early repayment charge if you overpay beyond a certain limit during the fixed or discounted period of your mortgage. This charge can be a percentage of the overpayment and can significantly eat into the financial benefits of overpaying.
Our overpayment allowance is 10% of our original loan value, which is over £30,000 a year. We can see our allowance and how much we have used by logging into our online mortgage account.
Loss of Access to Cash
Money used to overpay your mortgage is not easily accessible should you need it for an emergency. Unlike with a savings account, you can’t readily withdraw excess payments from your mortgage. If you think you might need access to cash shortly, overpaying your mortgage might not be the best idea.
Lower Returns Compared to Investments
The money you use to make mortgage overpayments could potentially achieve higher returns if invested wisely. If your mortgage interest rate is low, and you’re comfortable with the associated risks, investing could be a more profitable use of your extra money.
Overpaying vs. Saving: Which is Better?
Choosing between overpaying your mortgage and putting that money into a savings account can be a tricky decision. Here are a few factors to consider:
Savings Rates vs. Mortgage Rates
Compare the interest rate on your mortgage with the potential interest you could earn from a savings account. If your mortgage rate is higher than the savings rate, it may be more beneficial to overpay your mortgage. You can use a savings calculator to see how much money you will earn on your savings passed on the interest rate, vs how much money you will save on your mortgage.
Access to Funds
Money in a savings account is typically more accessible than money used to overpay a mortgage. If you think you might need quick access to your cash, you might be better off saving rather than overpaying.
Peace of Mind
The choice could also come down to personal preference. Some people get a greater sense of financial security from being mortgage-free, while others prefer the flexibility and accessibility of cash savings.
Overpaying vs. Paying Off Other Debts
If you have other, more expensive debts, such as credit cards or personal loans, it might be more beneficial to pay these off before considering mortgage overpayments. Here’s why:
Higher Interest Rates
Other types of debts often come with much higher interest rates than mortgages. Overpaying on these debts could save you more in interest payments in the long run.
Impact on Credit Score
Paying off your credit cards and other debts can help improve your credit score, which can be beneficial if you plan to remortgage or apply for different types of credit in the future.
Other Alternatives to Mortgage Overpayments
Mortgage overpayments aren’t the only way to use your extra cash. Here are a few alternatives:
Invest in a Pension
Contributing to a pension can provide you with a significant tax advantage. The government adds tax relief to your pension contributions, effectively boosting the amount being saved for your retirement.
Invest in an Offset Mortgage
An offset mortgage links your mortgage to a savings account. Instead of earning interest on your savings, the money is offset against your mortgage balance, reducing the amount of interest you pay.
Making the Decision: Is Overpaying Right for You?
Deciding whether to make mortgage overpayments is a personal decision that depends on your financial situation and goals. Making mortgage overpayments can be a good move if you’re comfortable with your current mortgage payments, have no expensive debts, and have adequate savings for emergencies.
However, if you have higher-interest debts, need access to cash, or want to take advantage of potential investment returns, other options might be more suitable. It can be a good idea to seek financial advice to help you make an informed decision.
Why I Overpay My Mortgage
I make a large overpayment on my mortgage every month. I make these regular monthly payments because we are due to remortgage next year and it will be at a higher interest rate. So I feel the right option for us it to pay as much of the mortgage off now so it will lower our monthly repayments when we reach the end of our fixed rate and it will also get us used to paying a larger mortgage when the time comes.
I am paying around twice as much as I expect our current mortgage will increase. I basically put any spare money into a lump sum overpayment at the end of each month.
I also have to mention that we have no other outstanding debt, other than student loans. We also have enough savings in high-interest savings accounts and premium bonds that would cover our living costs for over a year if both of us lost our jobs.
Before overpaying your mortgage, I recommend that you have an emergency fund as once you put money on your mortgage, you cannot withdraw it again. You could always save your money in an interest saving account every month, then once a year make a big payment on your mortgage rather than smaller regular overpayments. This allows you to save your money, get a higher rate of interest and then put some of that money on your mortgage while retaining some savings for an emergency fund.
You could reduce your mortgage term, which means you pay a larger amount each month but reduce the years you have to pay it off, but I prefer to keep my mortgage term longer and over-pay, as this gives me a bit more security if I’m ever unable to pay the larger amount one month.
Remember, the key to a sound financial strategy is balance. So, whether you decide to overpay your mortgage, save, invest, or a combination of these, ensure it fits with your broader financial plan and supports your long-term goals.