The recent increase in the cost of living has many homeowners looking for ways to reduce their monthly bills and ease the pressure. It may seem counterintuitive to some, but there are a good number of homeowners weighing up any spare cash they have and putting it toward paying off their mortgage. This certainly won’t save you any money in the short term, but it could just be the answer to reducing debts in the long term. Let’s delve into how beneficial overpaying could be for you and if there are any alternatives that could better suit your situation.
Potential Benefits of Overpaying on your Mortgage.
Believe it or not, mortgage overpayments are currently at an all-time, 20-year high, for those that find they have a small amount of spare cash left every month. This is the result of interest rate hikes causing households to struggle with reducing their debts. Through fear of potentially ending up in the same scenario further down the line, overpaying on your mortgage could save you thousands and significantly reduce the life of your mortgage. Benefits of mortgage overpayments include:
- Reduction in the length of your mortgage – ensuring that your overpayments reduce the debt of your mortgage and shorten the term, rather than reducing your monthly payments, helps you to be mortgage-free sooner.
- No overpayment interest – the amount you overpay each month will have no interest attached to it, meaning it will go directly toward paying off the debt.
- Savings on interest usually beats any returns on savings – most of the time (but not all) the money that you could save on interest through repaying your mortgage each month will beat the returns you could possibly make by putting the same amount of money into savings.
You Can Also Benefit When It Comes to Remortgaging.
Not only will you get the benefit of paying interest on a smaller amount of debt, but by overpaying you are also lowering your LTV (Loan to Value) ratio at a faster rate, meaning that it’s possible to get a cheaper deal. Usually, an LTV of 95% or above means that you wouldn’t be able to remortgage at all, but 90%, 85%, 80%, 75%, and 60% LTVs and below are where savings can be big and the top mortgage deals get significantly cheaper.
Possible Negatives to Overpaying.
There are always 2 sides to weigh up when it comes to protecting your future finances, and there are some possible negative outcomes that could be worth noting before you make any decisions on overpaying, these are:
- Overpayment limits – on fixed-rate deals, lenders typically limit the amount you’re able to overpay, to around 10% of the balance each year, however, NatWest, Metro, and Atom Bank are offering up to 20% overpayment a year for all borrowers.
- Penalties for overpaying – there can also be penalties or charges for overpaying over the percentage they have specified, usually between 1% and 5% of the amount you’ve overpaid.
- Tax implications - in some cases, mortgage interest is tax-deductible. By overpaying and reducing interest payments, you may lose out on potential tax benefits.
The Overpaying VS. Savings Debate: Which is Right for You?
If you happen to find that you have some spare cash at the end of each month, you may be wondering if that cash is worth overpaying on your mortgage or if it would be better put into a savings account. There is an argument for and against depending on your situation.
Rates on savings accounts and ISAs are at their highest levels in years right now, which is leading many homeowners to see what they could make by saving instead of overpaying on their mortgage. It’s important to understand, however, that if your mortgage rate is around the same, or higher than your savings rate, then it would be more beneficial to overpay.
The reverse isn’t always true, a higher savings rate could potentially beat overpaying your mortgage, but it will depend on whether you're planning on making a one-off overpayment or if you want to overpay monthly over a longer term, how much you have left to pay on your mortgage and whether you pay tax on savings interest.
To help you make the best decision for your circumstances, it may help to use a Mortgage Overpayment Calculator like this one from Money Saving Expert. It will help you to understand how much money you could save in both one-off and recurring mortgage overpayments and an indication of the interest you could earn if you put your cash into a savings account instead.
Important Factors to Consider Before Committing to Overpayments.
If you have made the decision that mortgage overpayments are right for you, then it is important to consider some important factors in the process first. Such as-
Clear Other, More Expensive Debts First.If you have other debts that are more expensive, then it will be beneficial to clear those before committing to mortgage overpayments. Larger debts, such as high-interest credit cards and loans can cause interest to build up quickly, so clearing these first can save you cash and give you more chance of clearing other debts earlier. This doesn’t include paying off student loans and 0% credit card debt.
Can You Overpay Without a Penalty?As mentioned previously, most lenders will let you overpay up to 10% of your remaining balance, some rates are higher, meaning that you can pay off your mortgage more quickly. Fixed-term or discount mortgage deals tend to come with an overpayment limit but SVRs and some tracker mortgages are usually free to overpay by as much as you want. Check with your lender to see if they allow overpayments, and if not then it’s advisable to work out the penalty fee to see if it will impact your savings more than continuing repayments at your current rate.
Sufficient Emergency Funds.Overpaying on your mortgage can sometimes mean that any savings or emergency cash is used for this purpose. If you find yourself in an emergency where spare cash is needed to fix a leaking roof or you’ve just been made redundant, this could force you into borrowing more money, which will reset the work you have put into reducing your mortgage debt in the first place. It’s advisable to keep an emergency fund as well as overpay your mortgage if possible.
How Does Overpaying on Your Mortgage Work?
Calling your lender or mortgage advisor is your first port of call when arranging to overpay on your mortgage. The most important information you need from them is to understand if the overpayment is allowed on your mortgage deal and if you can reduce the term of your mortgage with your overpayments. Lenders would like to give you this option if you would like to reduce next month's payment by the amount you have overpaid. This option doesn’t serve to help you financially, as it just means you're pausing slightly earlier, saving you a few days’ interest, meaning you would still pay as much as you would on your contractual payments.
Be very clear that you want to reduce your mortgage term with all your future overpayments, after doing this it’s quite simple to set up a monthly standing order of the same amount to overpay each month, or you could make stand-alone overpayments through your banking app.
Speak to an Independent Mortgage Advisor in Manchester for Expert Advice.
If you need help in understanding how to overpay on your mortgage, then our team here at TaylorMade, a specialist mortgage broker in Manchester, is here to answer all your questions and guide you with the very best advice and support.
We are an independent mortgage advisor in Manchester, equipped with the knowledge and contacts to ensure that your mortgage works for you. Get in touch today to see how we can help you.
