Everything to consider if you’re thinking about overpaying your mortgage

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 your borrowing, it might not always be the most sensible financial decision for you, and largely depends on your circumstances.

If you want to know if it’s the right approach for you, read on to find out everything to consider if you’re thinking about overpaying your mortgage.

An emergency fund can act as a cushion against financial shocks

The first thing you need to think about before overpaying your mortgage is whether you can actually afford to do so.

If you had £10,000 in your bank account which isn’t earning much interest, you may be tempted to use it to repay some of your mortgage instead. While this may be a good idea for your long-term financial wellbeing, it can have a serious impact in the short term.

As we discussed in a previous blog, it’s important to keep some of your wealth in cash to help you to absorb financial shocks. While most experts typically recommend three to six months’ worth of expenses, you may want to consider keeping a larger amount if you work in an industry which is particularly at risk.

If you deplete too much of your cash reserves to overpay your mortgage, you may find that you don’t have enough left to absorb financial disruptions, which can lead to greater problems down the line.

For example, if you are made redundant and don’t have enough savings to cover your outgoings, you may have to rely on expensive credit until you get back on your feet.

If you aren’t sure what a sensible amount of emergency funds for your lifestyle would look like, you may want to speak to a financial adviser, who can help you analyse your spending in greater detail.

Paying off high-interest debts first may be a sensible idea

Similarly, before you overpay on your mortgage in the interest of your long-term financial wellbeing, it may be more sensible to pay off other more expensive debts first.

Some debts, such as credit cards or bank overdrafts, charge a much higher interest rate than others. According to the price comparison website MoneySuperMarket, credit cards typically have an Annual Percentage Rate (APR) of around 19%.

At this rate of interest, debts can quickly spiral and become significantly larger if you don’t pay them off quickly. This is why you should typically consider paying off such debts before overpaying your mortgage.

Overpaying can reduce the amount of interest on the mortgage by a considerable amount

If you do decide to overpay your mortgage, it’s important to know the impact it will have on the debt, so you can plan your finances accordingly.

Mortgage calculators are a useful and free tool which you can use to do this, which can easily demonstrate how useful overpaying your mortgage would be for you.

For example, the table below shows the significant impact of increasing your monthly mortgage payments by just £100 on a 20-year mortgage with a 2.5% interest rate:

Source: Nationwide

As you can see, overpaying by only £100 extra per month over the length of the term could save you up to £6,291.25 in interest payments and reduce the length of the mortgage by two years and two months.

Some lenders have a cap on the amount you can overpay without triggering a charge

One important thing to bear in mind is that if you have a mortgage with a fixed, capped, or discounted interest rate period, there may be a cap on how much you can overpay over the course of a year without incurring charges.

This limit is typically around 10% of your remaining mortgage balance, although this amount varies between lenders. If your overpayment is above this limit, you may have to pay an early repayment charge (ERC).

The size of this charge also varies between lenders, as some ERCs are set at a fixed rate of 5% while others diminish in size as you approach the end of your interest period.

For example, if you took out a mortgage of £250,000, then you would typically be able to overpay by £25,000 each year without triggering a charge.

However, if you were to overpay by £35,000, then you would trigger an ERC on the extra £10,000. If your lender had a 5% charge, then you would have to pay an extra £500 in charges.

While paying more might enable you to pay off your mortgage more quickly, it may not be advisable as the charges would make your overpaying less effective. These charges are why it’s important that you carefully check the terms and conditions of your mortgage, as they can make a significant impact on your repayment strategy.

If you want to repay your mortgage in the most effective way, then you may want to speak to a financial adviser who can help you to navigate any potential pitfalls associated with overpayment.

Get in touch

If you’re considering overpaying your mortgage but aren’t sure if it’s the right decision for you, we can help. Email enquiries@prosserknowles.co.uk or click here to request a call back from one of our advisers.

Please note:

Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.