TL;DR
In short
- Overpaying your mortgage reduces the interest you pay.
- Depending on the lender and the type of overpayment, an overpayment may shorten the mortgage term or reduce the monthly payment.
- Check your overpayment allowance and any early repayment charge before you overpay.
- Overpaying is generally more worthwhile when your mortgage rate is higher than what you can earn on savings after tax.
- Keep an emergency fund and consider clearing more expensive debt first.
A mortgage is probably the most important financial commitment in your life. When deciding on it, you have to anticipate a number of events, such as death, birth, growth or a temporary drop in income. We like to look at the future in an optimistic way, so today we will look at one way to use spare money that may suit you, depending on your circumstances - overpaying your mortgage. When is it worthwhile to go for it? Does it always pay to overpay?
Is it worth overpaying a mortgage in the UK?
In principle, overpaying a mortgage is a very simple process - in exchange for giving back to the bank more than the original agreement, you reduce your balance and, depending on the lender and the type of overpayment, may shorten the term of the financing or reduce your monthly payment. Thus, although the interest rate doesn’t change, the total amount you will come to pay back will be lower. Pure profit, right?
How does overpaying affect my mortgage?
Depending on the lender and the type of overpayment, an overpayment may shorten the mortgage term or reduce the monthly payment, so check with your lender how it applies overpayments. Either way, a lower balance means less interest is charged. The earlier you overpay, the more interest you are likely to save, though overpaying later in the term can still reduce interest.
How much will I save?
As is often the case in finance, the answer is: it depends. How much you save depends on your mortgage interest rate, the repayment term, the amount borrowed and how much spare cash you can set aside. With this in mind, let’s look at some examples. The figures below are illustrative for a repayment mortgage at a constant interest rate and ignore fees and charges. You can also do your own calculation, for example, on the Halifax website.
Low regular overpayments
Imagine a young married couple who borrowed £150,000. Shortly after taking out the mortgage, they decided to overpay £100 every month. The original term was 20 years (240 months) and the interest rate was 6%.
| Year | Outstanding balance (without overpayment) | Outstanding balance (when overpaying) |
|---|---|---|
| 0 | £150,000 | £150,000 |
| 2 | £141,744 | £139,200 |
| 4 | £132,437 | £127,028 |
| 6 | £121,948 | £113,307 |
| 8 | £110,124 | £97,841 |
| 10 | £96,797 | £80,409 |
| 12 | £81,775 | £60,760 |
| 14 | £64,844 | £38,613 |
| 16 | £45,759 | £13,650 |
| 18 | £24,247 | £0 |
The table above shows that even small regular overpayments can reduce your balance faster.
The total saving - assuming the couple kept up their overpayments - would be approximately £18,286 in this illustrative model without intermediate payment rounding. That’s a big difference, right? With larger and longer-lasting mortgages, the savings will be even greater.
One-time overpayment
Now imagine that you have not been overpaying your mortgage and you receive an inheritance of £20,000. This time, our hypothetical mortgage is £260,000, the interest rate is 6.5% and the remaining repayment period is 25 years. How much can you save?
| Year | Outstanding balance (without overpayment) | Outstanding balance (when overpaying) |
|---|---|---|
| 0 | £260,000 | £240,000 |
| 2 | £251,127 | £228,358 |
| 4 | £241,025 | £215,105 |
| 6 | £229,525 | £200,017 |
| 8 | £216,434 | £182,840 |
| 10 | £201,530 | £163,286 |
| 12 | £184,562 | £141,025 |
| 14 | £165,246 | £115,682 |
| 16 | £143,256 | £86,831 |
| 18 | £118,223 | £53,986 |
| 20 | £89,723 | £16,594 |
| 21 | £74,027 | £0 |
For this table, the £20,000 overpayment is made at time 0 and the monthly payment remains approximately £1,755.54. Interest is calculated monthly at 6.5%/12, payments are made at month end and no fees are included. The balance is £0 once repaid.
The table shows how the one-off overpayment reduces the balance straight away and shortens the time needed to repay the mortgage.
Our calculations assume that the mortgage rate stays the same, which is rarely the case in practice. In reality, the savings can be higher or lower.
When is it a good idea to overpay a mortgage?
Overpaying is not always the best use of your money. Depending on the lender and the type of overpayment, an overpayment may shorten the mortgage term or reduce the monthly payment, so check with your lender how it applies overpayments. Overpayments reduce your balance but do not automatically replace future scheduled payments. Ask your lender before reducing or missing a payment. Read about the consequences of missed mortgage payments.
The saving from overpaying is roughly equivalent to earning your mortgage interest rate on the money, but that money is no longer easily accessible. Keep in mind that shares and other investments can also lose value.
Overpaying your mortgage may be worth considering if:
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You have an emergency fund to fall back on if you temporarily lose your job or face large unexpected expenses;
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You have no more expensive debt that would be better to clear first;
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You are comfortable that the money you overpay will no longer be easily accessible;
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Your mortgage lets you overpay within your allowance without an early repayment charge.
Disadvantages of overpaying
The main disadvantage of overpaying is that the money is tied up in your property and is no longer easily accessible. If you can earn more on savings or investments (after tax) than your mortgage rate, overpaying may be less worthwhile.
You also need to keep in mind the terms of your mortgage. Many lenders let you overpay up to around 10% of the outstanding balance each year during a fixed or discounted deal without an early repayment charge; some allow more, so check your mortgage offer. Overpaying above the allowance can trigger an early repayment charge on the excess, which reduces the benefit of overpaying.
How to save even more?
So far, we have assumed that you stay with one lender until your mortgage is repaid. Many people do, but there is another option to consider. You can remortgage, which may get you a lower interest rate on your mortgage. Combining a remortgage with overpayments lets you benefit from both:
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If you have received an inheritance, for example, you can use it to make the new mortgage smaller, so your monthly instalment will be lower from the start;
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A lower mortgage rate will make your instalments more affordable, so you will pay less to the lender overall and any overpayments can be higher (leaving more money in your household budget);
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By switching lenders, you may be able to choose a deal with a higher overpayment allowance.
Before switching, compare arrangement fees and any early repayment charge on your current deal.
Summary
As you can see, overpaying can be worthwhile for many borrowers, but whether it suits you depends on your mortgage rate, any charges, your savings and other debts. Therefore, consider whether, in your current financial situation, you can set aside additional money that will no longer be easily accessible.
You are welcome to contact us - the first consultation is completely free and does not obligate you to anything. We can help you compare suitable mortgage options, including their costs and overpayment terms. Do not wait, make an appointment today!
FAQ
Frequently asked questions
Does overpaying reduce my monthly payment or my term?
It depends on your lender and the type of overpayment: an overpayment may shorten your mortgage term or reduce your monthly payment. Check with your lender how it applies overpayments. Either way, overpaying reduces the interest you pay.
How much can I overpay without a charge?
Many lenders let you overpay up to around 10% of the outstanding balance each year during a fixed or discounted deal without an early repayment charge; some allow more, so check your mortgage offer. Overpaying above the allowance can trigger an early repayment charge on the excess.
How much will I save by overpaying?
It depends on your mortgage rate, balance, remaining term and how much you overpay. The earlier you overpay, the more interest you are likely to save, though overpaying later in the term can still reduce interest.
Should I overpay my mortgage or save?
Overpaying is generally more worthwhile when your mortgage rate is higher than what you can earn on savings after tax. If you can earn more on savings or investments (after tax) than your mortgage rate, overpaying may be less worthwhile. Money you overpay is no longer easily accessible.
When might overpaying not be a good idea?
Overpaying may not suit you if you have no emergency fund, have more expensive debt to clear first, or would pay an early repayment charge because you would go above your overpayment allowance.
