Should you make mortgage overpayments?
Essentially, overpaying on your mortgage will pay off your debt faster and the extra amount you pay will not be subject to interest.
One way to look at mortgage overpayments is to use the money you would normally put aside in a savings account to overpay instead.
If savings rates are low, you could potentially save a lot more money by using your saved money to avoid paying extra interest on your mortgage, instead of leaving it in an account to earn very little interest.
What is a mortgage overpayment?
A mortgage overpayment, as it seems, pays a little more than what you are required to pay on your monthly mortgage payment.
The extra amount you pay is not subject to the interest rate on your mortgage and could save you thousands of dollars in the long run.
Most mortgage providers will allow you to make overpayments at no additional cost of up to about 10% of the mortgage value per year, but this is something you should check first.
However, if you exceed the amount set out in the mortgage terms and conditions, you will be charged a prepayment penalty fee. This will usually be a percentage of the amount you paid above the overpayment threshold.
For example, if you overpay £ 12,000, which is a 12% overpayment and your mortgage only allows 10% of the mortgage value, you will likely be charged a percentage of the overpayment. (£ 2,000). These fees can be between 3% and 10%.
Other mortgage providers may have other fees and rules for overpaying, so always check the terms and conditions of your agreement.
How much could you save by overpaying?
The best way to calculate the savings you would make by making mortgage overpayments is to calculate how much interest on your debt would cost versus how much the money you saved will accumulate in interest.
For example, suppose you have a mortgage debt of £ 5,000 that you want to get rid of by paying too much. And let’s say the interest rate on your mortgage for the next 12 months is set at 3%, which means you have £ 200 in interest to pay.
Now take a look at your savings. Let’s say you have £ 5,000 in a savings account, with an interest rate of 1.3% over the next 12 months. It will increase by £ 65.
Instead of putting that money in a savings account, you can use it to overpay your mortgage and reduce the amount you would pay in interest, leaving you £ 135 better.
How to calculate how much money you could save by making mortgage overpayments:
Check the interest you’re paying on your mortgage over the next year
Check the interest on your savings account over the next year
If your mortgage interest rate is higher, you will probably be better off
Subtract the total you would pay (on the mortgage) from what you would save (on the savings account)
Check the mortgage overpayment terms (it’s usually up to 10% of the mortgage value in a year, but it’s not a rule)
Going over the mortgage overpayment threshold can cost you a lot more than any savings you’ve made, so be careful and make sure you’ve done your math correctly.
Can you overpay on any mortgage?
Almost all mortgages will allow customers to make overpayments. Double check this in the terms and conditions of the mortgage provider.
Each mortgage provider will have their own rules about how much you can overpay and different penalties for overpaying.
When to overpay
You should overpay if you have enough money in the bank to put it in a savings account.
But more importantly, you should only make mortgage overpayments if the savings rates are lower than the mortgage interest rate you’re paying.
If the savings rates are higher then putting your money in a savings account will earn you more money.
You should also only consider overpayments if you have enough “emergency” funds in the bank. If you’ve lost your job or suffered a change in circumstances that required additional money, you don’t want to have used all of your savings to pay off your mortgage.
With a savings account, you will likely be able to withdraw the money in an emergency. However, if you’ve spent your savings on overpaying your mortgage, the money is gone (unless your mortgage has flexible features like a compensatory mortgage or a “borrow” option – learn more here- below under ‘Mortgage overpayments compared to compensatory mortgages’).
It can save you hundreds or even thousands of pounds in interest, but having backup savings will give you some peace of mind.
Overpayments over savings and investments
If you have any money left over after making your monthly mortgage payments, you might want to do something with it to help it grow and look better on you and your family.
Some savings and investments come with risk – in general, those that offer better interest rates carry higher risk. But, there is also a risk of overpaying your mortgage even if the savings are greater than in a savings account i.e. you cannot get the money back.
As a rule of thumb, if the savings are more than your mortgage interest rate, always put your money in a savings account instead of making mortgage overpayments.
Investments are often a greater risk, so you might want to talk to an independent financial advisor first, or consider setting aside a smaller amount and using the rest to make mortgage overpayments or put it in a mortgage. ISA in cash.
However, if you have a compensatory mortgage or a mortgage with a repayment facility, then making mortgage overpayments may not be as risky, as you will still be able to get your money back (albeit with some drawbacks).
Mortgage overpayments compared to offsetting mortgages
With some of the most flexible mortgages on the market, such as compensatory mortgages, which are tied to your savings, you can overpay and borrow the money without penalty if you need the money again.
This can be a less risky option if you don’t have the cash available after you’ve made your mortgage overpayments.
However, compensatory mortgages and other more flexible arrangements tend to have a higher mortgage interest rate than others in the market.
Compensation mortgages are generally better if you are using your savings as mortgage overpayments. Therefore, if you plan to dip into your savings regularly, you won’t have as much of an impact on reducing your monthly mortgage payments.