The Value Of Overpaying Your Mortgage
If you are 'just about managing', and getting the money together each month to pay your mortgage is hard work, then overpaying your mortgage is probably well down your list of priorities. In fact, it may feel like an impossible dream.
Whether you can overpay right now or not, it's worth knowing what the benefits are. After reading our article, it might even incentivise you to review your budget!
To demonstrate the value, let's first be clear what overpaying is. Simply, it means making extra payments towards your mortgage, over and above your normal monthly payment. These extra payments can be one-off lump sums or a regular monthly extra amount.
A lump sum overpayment will usually mean your normal monthly payment is recalculated from when it is next due. With regular monthly overpayments, your normal monthly payment usually won't be recalculated until a later event such as your next annual statement date. In either case, however, most lenders will give you the option of keeping your normal payment the same. That means you're then overpaying every month without it costing you anything more.
The majority of mortgages calculate interest on the outstanding balance daily (although you should always check with your lender). With overpayments generally deducted from the outstanding balance within days of receipt, that means you're saving interest almost immediately. If you kept your normal monthly payment the same after making an overpayment then money that would have paid interest now reduces your outstanding balance.
So, what does all this actually mean in reality? Let's demonstrate with some figures (these are illustrative only and do not constitute advice on your particular circumstances). Consider a mortgage of £100,000 at a constant interest rate of 2.00% over 25 years. The normal monthly payment would be around £424, and the total interest payable would be about £27,156.
Now, let's assume you overpay by £50 every month for the full 25 years. The total interest payable would reduce to around £23,309, a saving of almost £4000. Not only that, you'd pay off the mortgage about 40 months early. That's more than three extra years of being mortgage free - how good does that sound?
Clearly this is a very simplified example. For a start, interest rates are unlikely to stay the same for the next 25 years. Given that interest rates are at a historic low right now, it is reasonable to assume that they will rise at some point in the future. Making overpayments now to reduce your outstanding mortgage balance can help to protect you from the pain of rising interest rates in the future. You can't control interest rates but you can perhaps control the amount the interest is charged on.
If you think overpaying isn't possible for you, then you'd be surprised how far a little sacrifice could go. £50 a month is not much more than £10 a week. Maybe you could sacrifice that weekly takeaway, have one or two less drinks on those weekend nights out or swap that daily coffee shop visit for a flask you made at home. It's surprising how much you can save by looking at the little things rather than the big things!
If you're not convinced yet, then there are more potential benefits.
- Overpaying could reduce your outstanding debt so that you qualify for a lower interest rate when you next remortgage. This is because the mortgage represents a smaller proportion of the value of your house.
- By overpaying, you will increase the equity in your house - that should certainly help you if you decide you want to move up the property ladder. It may also mean you can downsize and be mortgage free.
- If you find yourself in need of money because life has thrown you a curve-ball then having more equity in your home is probably going to help you. It might also help you through if something good happens, such as an opportunity to go travelling or take a part time job or start your own business.
- Overpaying when you can afford it can mean your normal monthly payment will be lower should your income reduce in the future. Some lenders will allow you to take a payment holiday or make reduced payments in times of difficulty if you have previously made overpayments.
Before you make an overpayment, you should always check whether there are penalties for doing so. However, even if your mortgage has early repayment charges, most lenders will allow you to pay off up to 10% of the balance each year without incurring any penalties. The conditions for this vary so you should always check with your mortgage lender first, for example there may be a minimum amount for a lump sum payment or they may only be possible at certain times.
If you have other debts then overpaying your mortgage may not be the most appropriate use of your money - we're happy to help you if you want to review your circumstances.
We know that overpaying is not possible for everyone. However, if you can afford it, or if you can make a little sacrifice somewhere then even small amounts can prove valuable in the long term. It's difficult to see how reducing your mortgage debt could be anything other than positive. Imagine that warm fuzzy feeling you'll get when you realise you've paid off your mortgage early and potentially saved thousands of pounds in the process!