At a time when record-low interest rates make saving seem like an unattractive option, if you have spare cash you may be tempted to overpay your mortgage. While overpaying can help to make a significant dent in the loan, this isn’t always the most sensible financial decision that you can make and largely depends on your circumstances.
If you want to know if it’s the right decision for you, read on to find out everything you need to consider if you’re thinking about overpaying your mortgage.
Pros of overpaying your mortgage
You’ll pay off the debt more quickly
One of the most obvious benefits of increasing your monthly mortgage payments is that you’ll be able to pay off the debt much sooner.
For example, according to Nationwide’s mortgage repayment calculator, if you had a 20-year £200,000 mortgage with a 2.5% interest rate, by increasing your monthly payments by only £100 you could shave two years and two months off your expected timeframe.
This can be a good way to secure some peace of mind, to know that you no longer have such a significant debt hanging over your head.
You’ll save a significant amount in interest payments
Another benefit of overpaying is that by reducing the length of the mortgage, you could save yourself money from paying reduced interest payments.
In the example given above, if you overpaid by £100 each month, over the full course of the mortgage you would need to pay £48,061 in interest, compared to £54,353 if you did not. This means that with only a small monthly increase, you would save a considerable £6,291 in interest payments.
When the time comes to upsize and move out of this house, the money you saved could be put to good use as part of the mortgage deposit for your second home.
The interest saved may be higher than returns on cash
One good reason for overpaying your mortgage is that the rate of interest on it is likely to be higher than the rate of interest offered by your bank if you had chosen to save that money in cash instead.
Due to record-low interest rates, the growth on any cash savings would be unlikely to keep pace with the rate of inflation, meaning that it would lose value in real terms.
While you could choose to invest it instead, as that typically offers a higher rate of returns, this would expose your money to risk.
Cons of overpaying your mortgage
The increased payments may make you financially vulnerable
While increasing your monthly payments can have significant benefits over the long term, if increasing your payments would make you vulnerable in the short term, it may be sensible not to do so. This is particularly true for younger people, who tend to be less financially secure.
If increasing your monthly payments would make you more financially vulnerable, an alternative might be to put aside that money into an emergency fund.
While this would mean that you wouldn’t be able to benefit from paying off your mortgage earlier, having the fund in place may be able to help you absorb financial shocks so they don’t impact your ability to keep up with mortgage payments.
Paying off other debts may save you more money
Even though overpaying your mortgage can have long-term financial benefits, it may be more sensible to pay off any more expensive debts first to ensure better short- and medium-term financial stability.
Some debts, such as credit cards, tend to have much larger interest rates. According to MoneySuperMarket, the average credit card charges an Annual Percentage Rate of around 19%.
At such a high rate of interest, debts can quickly spiral if you don’t pay them off quickly. Paying off these debts first and improving your short-term wellbeing can sometimes be more beneficial.
There may be charges for overpaying
Another important issue to consider is that if you have a mortgage with a fixed, capped, or discounted interest rate, there may be an upper limit on how much you can overpay your mortgage by. If you go over this, you could incur a charge.
Typically, this limit is around 10% of your remaining mortgage balance, although this does vary so you may want to check the terms and conditions of your agreement.
If you do breach this limit, you may incur an early repayment charge (ERC). Typically, this is around 5% of the total amount over the limit, although some lenders offer a charge that decreases as you get closer to paying off the loan.
For example, if you had £300,000 left to pay on your mortgage, you would typically be allowed to overpay by £30,000 each year without triggering the ERC.
These charges can make overpaying less effective, so if you’re considering doing so you may benefit from seeking professional advice first.
Get in touch
If you want to repay your mortgage in the most effective way, we can help. Please email info@investmentsense.co.uk or call 0115 933 8433.
Please note:
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
