For several months now the mortgage industry has seen mortgage rates plummet to unprecedented levels as the mortgage price war continues between lenders. With a rise in base rate not predicted until the latter part of the year at the earliest, many homeowners have a perfect opportunity to take full advantage of cheaper home loans.
It is important to remember rates will not stay this competitive forever and if you have been fortunate enough to capitalise on the low rates currently in the market, the extra money saved can present an excellent opportunity to make overpayments to your mortgage, reducing the debt before mortgage rates rise again.
An overpayment is an amount you can pay on top of the contractual monthly payment on your mortgage.
It is a common misconception however that reducing the term of your mortgage will give you that opportunity to clear your mortgage much sooner. This course of action allows you to pay the loan off more quickly, giving interest less time to build, with the end result of reducing the overall cost of your mortgage. Yet, overpaying and shortening the term do precisely the same thing. That being said, overpaying has the added the benefit of allowing you to stop at any time should your circumstances change.
Example of Mortgage Overpayments
| Term | Monthly Payment | Annual Cost | Total Interest over Term |
|---|---|---|---|
| 25 years | £948 | £11,380 | £84,530 |
| 20 years | £1,109 | £13,310 | £66,210 |
Illustration based on a £200,000 repayment mortgage and a 3% interest rate. Source: Moneysavingexpert
These figures demonstrate that shortening the mortgage term raises the monthly payments, but it reduces the total interest by £18,000, which is a significant saving.
On the other side of the coin, you can achieve the same outcome both in cost and time it takes to reduce the loan by simply overpaying a sum of £160 on a monthly basis or a lump sum of £2,000 annually.
Most fixed rate mortgages offer a degree of flexibility when it comes to making overpayments, allowing most to make an overpayment up to 10% of the total balance annually without incurring any penalties. Those on variable rate mortgages may find there may there are no overpayment restrictions imposed by lenders, however this does vary amongst providers, so it is always something worth investigating.
If you are considering going down the road of making overpayments, there are some important questions you may wish to address before you make that final decision.
Is overpaying a better option than saving?
It is worth noting that savings rates are at an all time low. You could therefore discover that you could save more from paying off your mortgage and reduce the total interest than the return on a similar amount in savings. It is worth noting that paying off your mortgage will give you a “guaranteed return”, where investing can be risky, which could either result in good returns or significant losses.
Considering the possibility of offset mortgages is always an option – this enables you to link your mortgage with your savings.
The value of your savings will be offset against your mortgage, so interest will only be charged on the mortgage amount, less your savings. Your savings simply just sit alongside your mortgage and save you interest. As repayments are based on the full mortgage amount, you are effectively making monthly overpayments, which allows you to clear the debt sooner.
Will overpaying allow you to get a cheaper mortgage deal?
The differences between overpaying and saving may be marginal to some, however another benefit of having a low mortgage could result in a better mortgage deal.
What determines this is the Loan to Value (LTV) amount, which is the percentage of the property value which is made up of the mortgage. The lower the LTV, the better deals that are available. Overpaying allows you to reduce the overall amount you owe, therefore giving you the opportunity to source a more competitive remortgage deal when the times comes.
Do you have emergency funds in place?
If you feel overpaying is the right move for you, before you decide to allocate extra money towards your mortgage, you should consider accumulating some emergency funds, into an instant-access savings account or cash ISA. If unforeseen circumstances were to arise, you will have funds available, rather than having all your funds tied up in your mortgage. An important point worth noting is that if your finances were to take a turn for the worse, lenders will still put you in arrears, even though you have been making overpayments.
There are indeed, many pros and cons to making overpayments to your mortgage, however this is something you have to weight up in terms of your financial circumstances. With that being said, interest rates are at record lows, so if you are currently making lower payments and you can afford to overpay, why not take advantage of the situation?