Things to consider before you overpay on your mortgage
You may be in the process of deciding whether it makes sense for you to consider making mortgage overpayments to pay off your mortgage sooner. 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 a better mortgage deal, and reducing your living costs, there are a few things we want to make sure you are aware of before you start.
What is a mortgage overpayment?
When you originally took out a mortgage, your lender would have informed you of the monthly payments 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 mortgage loan back).
Overpaying your mortgage is when you pay more towards your mortgage than the minimum amount or the normal monthly payment set by your lender, helping you be mortgage free sooner.
Key considerations when overpaying your mortgage
Before you start overpaying on your mortgage as you look to become mortgage free, 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 holds a higher repayment interest rate, then you should save money and pay this off first. You want to avoid interest charged on those debts, which will allow you to have more spare cash to help you be debt free and pay off your mortgage balance sooner.
Other debts can include overdrafts, credit cards, and personal loans.
2. Emergency funds
The best practice is to have cash savings in high-interest savings accounts such as an emergency fund that is easily accessible to cover 6 months of living expenses just in case of unexpected expenses or unforeseen circumstances.
3. Early repayment fees
Your mortgage provider will often try to limit how much you can overpay your mortgage as it is less profitable for them. Most mortgage advisers 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, your mortgage lender could charge you 1% to 5% of the outstanding mortgage balance, as an early repayment charge.
If you are unsure, you can find out by asking your lender, checking your mortgage offer document, or looking online before making any mortgage payments.
4. Understand the impact
If you decide you want to overpay your mortgage and maximise your interest savings, then it is important you contact your mortgage provider 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 outstanding balance. If you are just overpaying your mortgage on the interest, then this will not save you money or reduce your mortgage term.
5. Time your Mortgage Overpayments
It is worth thinking about when your lender calculates your mortgage interest. Your interest could be calculated daily, monthly, quarterly, or annually. If your mortgage interest is calculated daily, then you can make mortgage repayments at any time.
However, if it isn't, Sprive suggests 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.
The more regularly you make mortgage overpayments, the more interest you're likely to save. This could mean a monthly overpayment or even weekly. If you could save more as a single payment, you can choose to pay a lump sum overpayment.
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 with no early repayment charges. If you then decided to withdraw £50,000, you would begin paying regular monthly payments on that loan amount at the interest rate agreed.
Offset mortgages typically have higher rates and initial fees which is an extra cost to you, 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.