Make Mortgage Overpayments Work for You
To finance a house purchase, you’ll probably need a mortgage. After the down payment, lenders calculate monthly repayment plans that include both capital and interest. This ensures that you’re able to pay the mortgage off by the end of the agreed term. However, you’re not limited to the set rate of repayment.
Mortgage overpayment is an option. If you’re flush with cash or looking at a big promotion, paying more than the agreed monthly sum might be on your mind—and this can have its advantages.
Overpayment is best suited for people who have great financial stability, little-to-no outstanding debt, and more than enough emergency funds at their disposal, says Karen Noye, a mortgage consultant at the Quilter wealth management firm.
“It’s best to get rid of debt with the highest rate first,” Noye suggests in a Bloomberg report. “If you make overpayments, make sure you check the terms, so you don’t incur penalties. A majority of lenders allow 10% without an early repayment charge, you just want to be careful.”
Making mortgage overpayments can be done in two ways: either in occasional lump sums or a regular monthly overpayment.
If you have a lot of spare cash or receive a sizeable annual bonus from your employer, choosing to make an occasional lump sum overpayment might be the most suitable option for you. For example, if you have a £500,000 mortgage and you make a lump sum payment of £200,000, then you’ll be owing £300,000. Now, your lender can choose to either reduce your monthly payments and keep the mortgage term fixed, or reduce your mortgage term.
While saving money with the reduced monthly payments works if you foresee long-term financial stability, the reduced term allows you to clear your mortgage debt before the initially agreed-upon schedule, opening the door for future investments. Both options reduce the interest you’ll pay, though by different amounts.
Making monthly overpayments is best for borrowers who have extra monthly disposable income. For example, if you have a £1,000 monthly mortgage payment to make, you can simply increase it to £1,300 depending on your financial strength.
By doing this, you will effectively reduce your mortgage term and pay off your debt faster, while reducing your overall interest rate since you’re paying interest on fewer payments.
By overpaying on your mortgage, you can save a significant amount of money. For example, if you had a £300,000 mortgage repayment to make with 25 years left on it with a 3.5% interest rate, your monthly payment would be £1,502.
If you chose to increase this by £200 to £1,702, you would automatically reduce your mortgage term to 20 years, paying it off 5 years faster than with a regular monthly payment. Thus, if the interest rate remains the same throughout the mortgage term, you’d save £28,757 in interest on those 5 years shaved off.
Additionally, if you made a lump sum overpayment of £50,000 on the same mortgage while keeping your monthly payments fixed, you’ll save ad additional £57,570 in interest.
The advantages of overpaying your mortgage cannot be overstated. Imagine reaching the end of your mortgage term quicker and paying less interest overall.
Mortgage overpayments give homeowners more equity over their property since they’ll now have a much lower loan-to-value ratio (LTV), making them qualified for cheaper mortgage offers in case they choose to remortgage.
If you choose to make mortgage overpayments, you’ll not only be able to pay off your mortgage faster, but you’ll save more money on the accumulated interest over the lifetime of your mortgage contract. But before you decide to make overpayments, you should know it isn’t right for everyone. In fact, not every lender allows you to make overpayments on your mortgage. It’s not in the lender’s interest at all since overpayments mean less overall profit from accumulated interest payments. Some lending institutions do allow overpayment, but only within strict limits.
It’s important to talk to your lender before you decide to make an overpayment on your mortgage. Even when allowed, there are usually different terms and conditions tied to just how much you can overpay and penalties for non-compliance.
Avoid rushing into the decision to make overpayments. Choosing this option on your mortgage when you don’t have enough emergency funds can backfire terribly. While you want to save up on interest and pay off your mortgage faster, a general rule of thumb with mortgage overpayments is to always have readily accessible cash that’s equivalent to four months of living expenses to finance emergencies such as losing your job or incurring sudden medical expenses.