If you have any surplus cash floating around you may be considering reducing the balance, and therefore the term, of your mortgage.
Making overpayments on your mortgage can be a sound investment – it could save you tens of thousands of pounds in interest in the long term – but like any financial decision, there are many factors to take into account first.
Check your mortgage terms
The first point to consider is whether the terms of your mortgage allow you to make overpayments without being financially penalised – and if so, at what rate.
Many lenders make provision for an additional 10% of the mortgage balance to be paid off each year if you are still in an introductory discount period. After that you should be able to pay off more if you want to. However, this is not standard practice for all lenders and some may try to penalise you with fines for paying too much.
When to overpay
The timing can also impact your overpayments, depending on when your lender calculates interest. Most newer mortgage products calculate interest regularly so that any overpayment will be factored into the interest you pay in the next month. This may not be the case if you’ve had your mortgage for several years so it’s worth checking. If it’s worked out annually, for example, you’ll need to make your overpayment a few days before, to make it worthwhile.
Overpaying vs reduced term
If you have the option, it is better to make overpayments as and when you are able to, rather than officially increasing your repayments in order to reduce the term. This means you will have more room to manoeuvre if interest rates suddenly rise or you have a change in circumstances.
Overpaying vs saving
Whether to overpay on your mortgage or to put your money into a savings account is a tricky one and depends largely on the savings rates available. In very general terms, saving pays off if you can get a higher rate on your savings than you currently pay on your mortgage – which is probably unlikely for most people at the moment.
If the savings rate is lower than your mortgage rate, then paying the debt will leave you better off in terms of the savings you make from a lower balance compared to the amount your money will earn in a savings account. It’s also worth pointing out that even small overpayments can have a big impact on the overall balance of your mortgage.
Before you decide, it’s worth doing a bit of research to see what savings products are currently available.
If you’ve now decided that overpaying is a good idea, there are also a few other points to consider, such as clearing other more expensive debts first, such as credit card debts and high interest loans, as it’s likely this will improve your cash flow and financial situation more in the short term.
If you have extra cash, you may want to build up an emergency fund of at least a few months’ wages before committing all of it elsewhere. Some mortgages allow you to borrow back any overpayments you have made without penalty should you need it again.
There are various calculators available online which can give you an idea of how much you would save overall by repaying certain amounts each month, which may help you decide either way.