Is there a Good Time to Overpay on Your Mortgage?
3 minute read
Record-low interest rates have been hitting savers hard for the last few years, but for mortgage borrowers, now is an excellent time to make your disposable income work for you. Rather than putting your hard-earned income into a savings account that will pay 1.5 percent interest at best, many homeowners are taking this opportunity to drive down the cost of their borrowing by overpaying on their mortgage. Even small monthly overpayments can make a significant difference to the overall cost of the loan, as any overpayment will be used to directly pay off the loan capital. By chipping away at the principal amount, homeowners can considerably reduce the interest they pay over the term of the loan.
Maximum Overpayment Limits
Most mortgage lenders allow borrowers to make overpayments on their mortgage without incurring a penalty. Typically, this is equivalent to 10 percent of the total mortgage amount every year. However, there are also some lenders, such as Metro Bank and Tesco Bank, which allow borrowers to make overpayments of up to 20 percent of the mortgage’s value every year. Exceeding these overpayment limits can be costly, so it is important you ensure any overpayments remain within the penalty-free range or if a penalty is payable that it is financially worthwhile still doing so. One of the most common ways to do this is to ask the mortgage lender to increase your mortgage repayment by a fixed amount, which is paid by direct debit every month. Even a small monthly overpayment of £50 or £100 can make a big difference because the money will only be used to repay the loan capital and not the interest charges.*
Mortgage Overpayments in Action
Based on a typical fixed mortgage rate of around 2 percent, a borrower with a £250,000 repayment mortgage who makes an overpayment of just £100 every month could cut two-and-a-half years off their repayment term. They could also avoid paying an additional £8,000 in interest. If the same borrower could increase their overpayment to £250 every month then the savings would be even more dramatic. They could shave £16,723 off the cost of their interest payments over the lifetime of the mortgage and reduce the term of the loan by nearly six years. In the above example of a £250,000 mortgage, the borrower would have to be earning 2.5 percent on their savings to match the equivalent saving they could make by overpaying their mortgage.
In the current climate, using disposable income to make mortgage overpayments seems like a no-brainer, but there are other considerations to take into account. If you also have more expensive debts, such as credit cards or overdrafts, then you should consider the merits of repaying those first. With interest rates that can reach up to 20 percent, any savings you make on the cost of your mortgage could be dwarfed by the cost of credit card interest. You should also only make overpayments on a mortgage when you already have a savings pot in place. Once a mortgage overpayment is made, the money cannot be accessed again. Therefore, borrowers should make sure they have sufficient funds to cover unexpected eventualities, such as the loss of a job, before they overpay. For more in-depth advice about mortgage overpayments, please speak to one of our specialist mortgage advisers today. *The vast majority of lenders calculate interest daily so any overpayments are immediately used to reduce the debt. A very small number calculate interest annually, in which case it may be preferable to make a single overpayment each year.