Things to consider before you overpay on your mortgage
You may be in the process of deciding whether it makes sense for you to pay off your mortgage more quickly. If you are not aware of the benefits of doing so, we recommend you read this article here. Whilst there are definite benefits, such as earning a tax free return, getting access to better mortgage deals and reducing your living costs, there are a few things we want to make sure you are aware of before you start.
What is an overpayment?
When you originally took out a mortgage, your lender would have informed you of the monthly repayments you are required to make. This will be dependent on the amount you borrow, the interest rate of the product you selected and the term (the period of time in which you agreed to pay the loan back). Mortgage overpayments are where you pay more towards your mortgage than the minimum amount set by your lender.
Before you start overpaying, there are a few things Sprive recommends you take into consideration:
1. Pay off any expensive debts first – if you have other outstanding debt that results in a higher interest charge, then you should pay this off first. You want to avoid interest building on those debts, which will allow you to have more cash to help you be debt free sooner. Other debts can include overdrafts, credit cards and personal loans.
2. Emergency funds – best practice is to have cash in a high interest savings account that is easily accessible to cover 6 months of living expenses just in case the unexpected happens.
3. Early repayment fees – lenders often try to limit how much you can overpay, as they earn less in interest. Most lenders will allow you to overpay 10% of the loan outstanding each year, but it is important you understand the restrictions based on the product you are on. If you pay above the limit, the bank could charge you 1% to 5% of the outstanding mortgage balance. If you are unsure, you can find out by asking your lender, checking your mortgage offer document or looking online before making any overpayments.
4. Understand the impact – if you decide you want to overpay and want to maximise your interest savings, then it is important you contact your lender and inform them that you want your overpayments to reduce your mortgage balance and your future repayments to stay the same. You want to make sure that your overpayments are paying off your overall balance and not just the interest. If you are just overpaying on the interest, then this will not save you money or reduce your term.
5. Time your payments –it is worth thinking about when your lender calculates interest on your mortgage. Your interest could be calculated daily, monthly, quarterly or annually. If your interest is calculated daily, then you can make payments at any time. However, if it isn’t then, Sprive recommends you make the payment a day before the interest is calculated. You are better off putting your money into a high interest savings account, if your interest is not due to be calculated for another few months.
6. Flexible Mortgage / Offset Mortgages – as you approach standard variable rate (SVR) on your existing deal, if you are keen to save more money, then it may make sense to select a product that provides increased flexibility and allows you to make unlimited early repayments.
Offset mortgages allow you to overpay on your mortgage without restriction and it has the additional benefit of being able to withdraw the cash back without penalty.
For example if you had a £300,000 loan and had £300,000 in savings, you could put all the savings against your mortgage offset account and pay the lender nothing. If you then decided to withdraw £50,000, you would begin paying monthly payments on that loan amount at the interest rate agreed. Offset mortgages typically have higher rates and initial fees, so you need to be careful that the costs do not outweigh the benefit earned through savings.
7. Can you afford it? – make sure you can afford to overpay, and consider how this will affect your finances. If you think you may not have enough money left at the end of each month to go towards overpaying your mortgage, then see if you are able to find creative ways of reducing your expenses without dramatically impacting your lifestyle. Our article on how to be a super saver might be helpful.