If you’ve got a bit of spare cash it can be tempting to chip away at your mortgage with early repayments, but is this worthwhile?
This guide outlines the pros and cons of overpaying your mortgage.
Should you pay off your mortgage early?
You may hear this referred to as "overpaying your mortgage" or "making overpayments".
At its simplest, it may be worth making overpayments to pay off your mortgage early if your mortgage rate is higher than your savings rate. In this case, you will be saving more in interest than you would make by putting the money in a savings account.
However, there are other considerations:
- Paying back early may incur fees
- Paying back early may not reduce the mortgage term
- You may save more money by paying off other, more expensive debt first
Will overpayments reduce the mortgage term?
If you are considering making overpayments, speak to your lender to find out whether this will reduce the next monthly payment but keep the overall mortgage term the same or whether it will reduce the mortgage term. The latter is preferable.
The biggest savings are made when overpayments chip away at the term of the mortgage, as there is an incrementally shorter amount of time you will have to pay interest.
The lender is aware of this, however, and there are often things in place to protect their earning capacity. Remember: the profit they make on the mortgage comes primarily from the interest payments.
The benefits of overpaying your mortgage
Because of the low interest rates on savings accounts at the moment, you stand to make savings on mortgage interest that will be greater than interest you would earn if you put the equivalent amount into a savings account.
Paying off early means you are less restricted by debt. You are also reducing your Loan to Value (LTV) ratio, meaning remortgaging will be easier.
You will have the option to switch back to regular repayments if your circumstances change and you are no longer able to afford overpaying.
The drawbacks of overpaying your mortgage
Early repayment often incurs charges, usually 1-5% of the amount repaid. This amount will likely reduce as you reach the end of your mortgage term: this is the lender trying to protect their earning potential from your mortgage.
You risk losing an emergency fund if you plug all extra cash into your mortgage. Avoid the situation where you are forced to take out a high interest personal loan in an emergency; in this case overpayments may be counterproductive.
If your circumstances change, overpayments now don’t protect you against charges for going into arrears further down the line.
How to decide whether it is worth overpaying your mortgage
Be aware of when the interest is calculated on your mortgage, and make repayments as close as possible before this date. This will give your overpayment maximum effectiveness. On newer mortgages this is less relevant, as interest is often calculated in real time, or daily. On older mortgages however, this may be quarterly or even annually, and can make a real impact.
We recommend speaking to your lender, and asking them how it will work. If you get a positive number when you subtract any fees and charges from the amount you stand to save, it may be worth overpaying. Obviously the decision is ultimately in your hands, but the advice in this guide should go some way to clarifying the situation.
If you have any other questions about overpaying your mortgage, get in touch and we’ll do our best to advise.