Overpaying on your mortgage can significantly reduce your mortgage term. An overpayment of just £50 per month can take years off your mortgage and save you a lot of money in interest in the long run. How nice would it be to be mortgage free? I could think of much better ways of spending my money every month rather than paying the bank! Your mortgage is a probably the biggest loan you will ever have and the quicker you reduce this debt the better. However there are some considerations to take into account prior to doing this.
As a rule of thumb, clear your most costly debts first. If you have a credit card or loan, the interest will most likely be considerably higher than the interest on your mortgage. Some credit cards have an interest rate of 19% which is much higher than any mortgage agreement. Some credit cards carry 0% interest as an introductory rate and the savvy people amongst us will know how to swap and change credit cards to be always be ahead of the game and never pay any interest. If this is the case then great, you should be able to overpay on your mortgage. On a similar vein, some loans do not allow early repayments so you could be forced to keep paying the agreed loan payments. If this is the case then you can overpay on your mortgage as you won’t be able to overpay on your loan.
The glory days of high interest earning accounts for savers are gone however there are some good deals out there if you want to lock your money away for a length of time. When considering the question of whether to overpay on your mortgage you should ask yourself whether overpaying the mortgage beats the highest paying savings account available. If we have a look at an example; £5,000 mortgage debt at 5% creates an annual interest cost of £250. If you put £5’000 in a savings account that pays 2%, your annual interest saved is £100. As you can see, overpaying on the mortgage is the best money saving venture as the mortgage will cost you more in the long run.
Possible overpayment penalties
Some lenders who offer special fixed rate, tracker or discounted deals do so to entice you in, in the hope that you will stay with them once the cheap rate ends and the mortgage becomes more expensive. These lenders do not like you overpaying on your mortgage as they would rather you take longer to repay it as this means more money for them. Luckily, many mortgage lenders allow you to overpay up to 10% of the outstanding mortgage debt each year without penalties. Unless you have a big windfall, 10% is quite high so you should be able to take advantage of this allowance and pay off what you can. It’s worth checking that your lender won’t reduce your normal payments or reduce the term of your mortgage as this will lock you into higher payments.
The advantage of overpaying
The beauty of overpaying is that you can pay more some months, less the next or stop the overpayments altogether. You can overpay on a monthly basis or a lump sum at the end of a period. Overpaying is a solid way of reducing the mortgage term but it gives you the flexibility of choosing when you overpay and what amount.
For example, if you had a 25 year mortgage at 3% for £200.000 you would pay £11.380 over the year, broken down to £948 per month. Over the term you would pay back a massive £84’530 in interest. If you overpaid by £160 per month or £2000 per year, you can take 5 years off the mortgage term. If you took the mortgage over 20 years with the same interest rate, you would pay annually £13’310, broken down to £1’109 monthly. As you can see, overpaying and tying yourself into a shorter mortgage term are very similar; but overpaying gives you added flexibility.
If you want to see how you can benefit from overpaying, please download my Mortgage calculator. I have made this myself and it works brilliantly, just fill in the gaps where instructed, it will take less than a minute of your time.
How to overpay
Interest is calculated in different ways, sometimes monthly, sometimes annually but on the most parts it is done daily. If it is done daily then you will find that overpaying steadily on a monthly basis is fine. If your interest is added annually and you overpay after this is calculated then you could find yourself paying more interest than you would do if you have overpaid before the calculation date.
Should you throw all your spare money at your mortgage?
If you have read my ‘ how to save money with a cash flow or budget’ article then you will be familiar with my ‘saving for a rainy day’ concept. If you have not read this article then you can find it linked at the bottom of the page. It is always worth keeping a little extra back to pay for those unforeseen emergencies, i.e, the broken boiler, the expensive car repairs or similar money draining events. If you overpay on your mortgage that money is gone, it is not like a savings account where you can take the money back out. If you miss a mortgage payment then the overpayments do not help your case, so only overpay if you can afford to let that money go. If you want to have access to your money then you could consider an easy access saving account or filling up a cash IS. Overpaying on your mortgage is a long term investment and should only be done if you can afford it.
You may like to read – How to save money with a cash flow or budget.