The pros and cons of overpaying your mortgage

Posted on by meglidster

If you’re fortunate to find yourself with disposable income, you may be considering how best to use it. One option would be to make an overpayment on your mortgage. This is where you pay back more than your agreed monthly payment to your mortgage provider to reduce your debt. There are advantages and disadvantages to overpaying your mortgage, and these should be considered before you make a decision. In this article we’ll discuss some of these factors.

Overpayment amount and frequency

Overpayments can be made regularly, or in a lump sum. Many mortgage providers will impose a limit on how much can be overpaid each financial year. This is usually around 10% of the remaining debt. If more than this limit is overpaid, an Early Repayment Charge may be applied by the mortgage lender. This could be between 1% and 5% of the additional overpayment value, and could make it less financially advantageous.

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Benefits of making a mortgage overpayment

The biggest benefit of making a mortgage overpayment is that it will reduce the term of your mortgage. Rather than having 20 years remaining on your mortgage, for example, you may reduce this by a year or two, depending on the amount overpaid. Being mortgage free earlier in life will give you greater financial freedom in retirement. It also builds greater equity in your home should you choose to move house.

Your Loan-to-Value (LTV) ratio is the amount you are wanting to borrow against the value of the property.

Example:
If the property you’re looking to purchase is £150,000 and your deposit value is £15,000, your LTV ratio is 90%.

The lower your LTV ratio, the better position you are in. By making an overpayment on the mortgage of your current property, you will reduce the amount you are looking to borrow on a property of equal value in the future. Your LTV is lower, therefore you’ll be able to access better mortgage deals.

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Another great advantage of mortgage overpayments is you’ll save the interest that you’d have paid on the amount you overpay. So not only are you reducing the overall mortgage term, but the total amount owed will also be reduced.

Drawbacks of making a mortgage overpayment

The biggest factor you should consider before making an overpayment is whether the money could be better placed elsewhere. If you have other outstanding debts, with a higher interest rate than your mortgage, consider paying these off first. This may be credit cards, car loan repayments or an overdraft, for example.

You should consider if there is a savings account that would offer you a higher interest rate. If the interest rate is higher than your mortgage interest rate, it could be financially advantageous to invest money here. It’s important to balance saving benefits here in comparison to longer-term savings made by overpaying on your mortgage, though.

Before assigning any additional funds to mortgage overpayments, you should consider if you have savings in case of emergency. Whilst paying off your mortgage will bring longer-term savings, it may leave you without the funds you need in emergencies. For example, if your boiler needs replacing or a pipe bursts, this can be costly. It should be noted that flexible mortgages allow you to alter your payments depending on your current circumstances. You can make overpayments in months when you have more disposable income, and also draw down money when needed too. Due to the flexibility offered, these mortgage types will usually have higher interest rates on them. They therefore may not be suitable for you.

Depending on the arrangements you have in place, an alternative could be to pay money into a pension. Like overpaying on your mortgage, this will be of longer-term benefit to yourself, rather than a short-term gain. There are annual allowances to consider, but the bigger your pension pot, the more financially secure your retirement will be.

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Mortgage interest calculations

Should you decide to make a mortgage overpayment, timing is important. Whether your mortgage interest is calculated annually or daily is an important factor. If it is calculated daily, the sooner you are able to make the overpayment, the more interest you will be saving. If your mortgage has annually calculated mortgage interest, a lump-sum overpayment should be made just before the calculation date. Payments made after the calculation date will not impact the interest saved until after the next calculation, which could be a year later.

How can Bell Mortgage Solutions help?

As with any mortgage-related questions, our team are able to help. We can discuss your circumstances with you and help you determine if an overpayment is the right solution for you. If it is, we can help with the timing of the overpayment too. Contact us now to book a consultation.

Please note: Your home may be repossessed if you do not keep up repayments on your mortgage.

The information contained within was correct at the time of publication but is subject to change.