Should I overpay my mortgage?

Should I overpay my mortgage?
It’s a question of whether you save, or whether you overpay your mortgage

In the current economic climate, many homeowners are choosing to make extra payments on their mortgages to counteract the effects of high interest rates. If you have the available funds, overpaying your mortgage can be a wise strategy and might save you tens of thousands of pounds. However, it’s worth noting that interest rates on savings accounts have also risen considerably. For those with older, lower-rate mortgages, putting money into savings could be a more advantageous option. This guide is designed to help you evaluate which approach is most beneficial for your situation.

Overpaying often beats saving – but not always

Properly managing your mortgage overpayments can significantly enhance your financial situation because…

• You’ll be reducing the principal debt accumulated from purchasing your home, which allows you to potentially pay off your mortgage earlier. It’s crucial to ensure that overpayments are applied to reduce the debt and shorten the loan term, rather than just lowering your monthly payments.
• Interest is not charged on the extra amount you overpay.
• The savings on interest typically (though not always) surpass the potential returns you might earn from saving the money elsewhere.

Determining if making extra mortgage payments is the right move for you can be complex.

Start by evaluating whether you should use extra funds to pay down your mortgage or invest them elsewhere—this is a crucial choice you’ll face. As a general guideline:

IMPORTANT PRINCIPLE: If your mortgage interest rate is comparable to or exceeds your savings interest rate, it’s wise to consider making extra payments on your mortgage.

This is because, in terms of savings, the reverse scenario isn’t always true. While a higher savings rate might sometimes outperform the benefits of overpaying your mortgage, it’s not a given. The outcome depends on various factors, such as whether you’re considering a single overpayment or a regular one (e.g., monthly) over an extended period. Additionally, the size of your mortgage debt, the remaining term of your mortgage, and whether you’re taxed on savings interest all play a role.

To determine which option is more advantageous, use our Should I Overpay My Mortgage? calculator below to evaluate if saving or overpaying your mortgage is more beneficial. The following section provides details on how to assess and compare these options.

If it turns out that overpaying is the better choice, check the rest of this guide for information on how to proceed with making an overpayment.

How much could overpaying save you?

Making extra payments on your mortgage can save you tens of thousands of pounds throughout its duration.

The table illustrates that these overpayments don’t need to be substantial. Contributing just £50 or £100 each month can significantly cut down the interest you owe, shorten the length of your mortgage, and might even surpass the benefits of interest earned from savings accounts.

How much will overpaying your mortgage save you?

By making additional payments on your loan, you can save substantial amounts in interest. This approach not only reduces the principal debt but also eliminates the interest you would have accrued on that portion of the loan in the future.

It’s important to understand that this isn’t merely about comparing overpaying your mortgage with your existing savings. Instead, the key question is whether overpaying surpasses the returns from the best available savings options. Many individuals are still receiving minimal interest rates, even though higher-yield savings accounts are within reach.

So, if you haven’t already, check the Top Savings Accounts and Top Cash ISA guides for the top-paying accounts.

On another note, making extra payments on your mortgage might still be more beneficial than opting for a higher savings interest rate, particularly if you plan to make these additional payments consistently over an extended period.

Three things to check before overpaying

If you’re reading this, I’ll assume you have some extra funds on hand. According to our calculator, it seems that applying this money towards your mortgage would be more advantageous than depositing it into savings.

However, before you decide to allocate all your extra funds towards your mortgage, it’s essential to first review the following considerations…

Check 1: Do you have other, expensive debts? If so, clear those first

An essential guideline for managing debt is to prioritize paying off the most costly debts first. By addressing these high-interest obligations, you prevent interest from accumulating rapidly, which helps save money and accelerates debt repayment. As a general strategy…

Clear high-interest credit cards and loans before overpaying your mortgage, as they’re usually more expensive.

However, there are certain types of debt you might want to settle or manage differently before considering additional mortgage payments, such as…

Student loan debts

This specifically refers to official loans from the Student Loans Company.

Students who began their university studies in England or Wales from 1998 to 2011, as well as those from Northern Ireland and Scotland who commenced at any point in time.

For these students, the interest is set at either the base rate plus one percentage point or the rate of inflation (RPI), whichever is lower, making it a relatively inexpensive form of long-term debt. While it’s possible that a mortgage might be cheaper than the student loan if inflation is high and interest rates are low, this situation is unlikely to be sustainable over the long term.

Moreover, if your income doesn’t exceed a specific threshold (which varies depending on when and where you attended university), you won’t be required to make monthly loan repayments. Given the unique repayment structure of these loans, it’s generally advisable to prioritize paying off your mortgage before focusing on repaying your student loan.

Students who started university between 2012 and 2022 in England, or since 2012 in Wales

For these students, interest accrues at the rate of inflation plus 3% while you’re still studying. After that, it varies on a sliding scale from the Retail Price Index (RPI) to RPI+3%, based on your income. Consequently, for many students, the interest rate on their student loans could exceed that of their mortgage.

However, this doesn’t necessarily mean you should prioritize repaying your student loan over making additional payments on your mortgage. Whether it’s advantageous to overpay your student loan depends on whether you’re likely to settle the entire amount before it’s forgiven in 30 years. Many individuals won’t repay it fully, and if making extra payments on your loan simply reduces your current cash flow without a significant long-term benefit, it may not be worth it.

Credit card debt at 0%

It’s arguable that those who are financially savvy, with top credit scores, strict organisation and timekeeping who disloyally shift from 0% credit deal to 0% deal (see the best balance transfers guide) should also pay their mortgage off before their credit cards, as even with balance transfer fees they’re cheaper than most mortgages.

Nevertheless, this approach is best suited for those with exceptional financial discipline. For most people who may not be as confident in their ability to maintain such discipline, it is typically wiser to prioritize paying off credit card debt first, even if it involves a short-term 0% interest rate.

Check 2: Can you overpay without penalty? Most can overpay 10% per year, but get it wrong and you risk £1,000s in fees

How much you can overpay depends on what sort of deal you have…

• If you’re on a fix or discount mortgage deal. Most lenders allow you to pay 10% of your mortgage balance as an overpayment per year without penalty.
• If you’re on an SVR (and some trackers). Typically, you have the option to overpay as much as you wish here (especially if you’re on a tracker mortgage). However, since many Standard Variable Rates (SVRs) can be quite high, it’s advisable to explore the possibility of remortgaging. This approach might offer more savings compared to just making additional payments.

If your lender permits overpayments but you exceed their allowable limit, you will typically incur a fee, which usually ranges from 1% to 5% of the excess amount.

Here’s an illustrative example:

Imagine you have a five-year fixed-rate mortgage for £150,000, and two years into the term, you decide to make an extra payment. If your lender allows penalty-free overpayments up to 10% of the loan amount (£15,000) but you overpay £20,000, you will be charged a penalty on the £5,000 that exceeds the limit. In this case, with a 3% penalty rate, this amounts to £150.

It’s important to note that this ‘percentage left on loan’ guideline is a rough estimate, so always confirm with your lender for precise details.

Such penalties are imposed because lenders want to retain you as a customer beyond the initial low-rate period and have anticipated earning a certain amount of interest over the life of the mortgage. When you overpay, they receive less interest than expected.

Check 3: Do you have a sufficient emergency fund?

It’s often recommended to maintain a cash emergency fund if you’re debt-free aside from your mortgage.

However, when you make extra payments on your mortgage, that cash is essentially tied up and not easily accessible. If an emergency arises—such as a leaking roof or a job loss (not just a new pair of shoes)—and you’ve used all your extra cash to pay down the mortgage, you might end up needing to borrow again. Despite your previous overpayments, lenders may still charge you fees if you miss a mortgage payment.

Therefore, it’s wise to keep an emergency fund in a top savings account. Generally, having three to six months’ worth of living expenses saved up is a solid rule of thumb, providing a cushion if you lose your job. Before redirecting extra income, like a salary increase, towards mortgage overpayments, prioritize building up this emergency fund.

This advice holds true even if mortgage calculators suggest you’d financially benefit more from overpaying your mortgage. This concept is known as ‘a premium for liquidity,’ which means giving up some interest earnings in exchange for having quick access to your cash when you need it.

The exception – mortgages with flexible features, such as offset mortgages

Mortgages with flexible features, like offset mortgages or those with a ‘borrow-back’ option, enable you to make additional payments and then access those funds again if necessary. This means you can pay extra towards your mortgage and, if needed, withdraw that money without facing any penalties. For such mortgages, it’s advantageous to direct any extra cash into your mortgage.

These types of mortgages can function similarly to a high-interest savings account, as you’re essentially earning the mortgage interest rate on your saved money without incurring tax. However, it’s worth noting that this approach is somewhat less advantageous because personal savings allowances ensure that all interest from savings accounts is tax-free.

This example shows how it can work:

With a mortgage of £150,000 over 25 years, placing £25,000 of savings into an offset account could allow you to clear your mortgage nearly two years earlier, reducing your interest payments by £3,350, while still retaining access to your savings if necessary.

However, it’s important not to interpret this as a recommendation for everyone to choose such mortgages. These mortgages often come with higher interest rates compared to standard ones, and in many cases, the additional cost of the mortgage outweighs the benefits of the savings.

Additionally, some of the flexible features associated with these mortgages might not be well-known, so it’s advisable to inquire with your lender to see if this option is available.

Remortgaging? You could save twice over

When you make extra payments on your mortgage, you not only reduce the amount of interest you owe on a smaller debt, but you also accelerate the decrease in your loan-to-value (LTV) ratio. This can be advantageous when you’re looking to remortgage, potentially qualifying you for a more favorable deal compared to if you hadn’t made those extra payments.

If you have a significant amount of savings or are consistently overpaying on your mortgage, using those funds to lower your outstanding balance and decrease your LTV can open the door to better interest rates.

However, it’s important to note that for the extra payments to have a noticeable impact, you need to be nearing one of the critical LTV thresholds where lenders’ terms become much more favorable and costs drop significantly. If you’re close to these thresholds, the financial benefits can be substantial. Generally, the main LTV thresholds are:

95% LTV: Above this, you won’t be able to remortgage at all.
90%, 85%, 80%, 75% and 60% LTVs: Go below each of these and the top mortgage deals get cheaper.

Rates get cheaper as your LTV drops…

How to cut the cost of your mortgage

If you’re approaching the limit of an LTV band or nearing the end of your mortgage term, it’s crucial to explore the market for potentially better offers.

Take a quick look at our Mortgage best buys tool to see what rates are available or find a broker to help you search in our Cheap mortgage finding guide.

How do I overpay my mortgage?

If you’ve carefully reviewed all the calculations and assessments and have concluded that making extra payments on your mortgage is the best choice, the easiest approach, especially for your first overpayment, is to contact your lender directly. This allows you to confirm that such overpayments are permitted and to ensure that the extra payments are applied correctly.

When you make an overpayment, your lender might present you with two options:

• Either to reduce next month’s payment by the amount you’ve overpaid, or
• To keep payments the same and reduce your mortgage term instead.

Here’s a key point to keep in mind: if you don’t manage this correctly, your overpayments might not be as beneficial as you’d hope. Always instruct your lender to apply your overpayments towards shortening the term of your mortgage.

If your overpayment simply reduces next month’s payment, you’re essentially paying a bit ahead, which might only save you a few days’ worth of interest. This approach won’t significantly lower your overall mortgage term or substantially alter your repayment schedule.

Make sure you explicitly state that you want any additional payments to be used to cut down the mortgage term. Once you’ve confirmed this arrangement, you can usually make these extra payments through online banking by setting up your mortgage account as a new payee, and then paying as needed. Alternatively, if you prefer to overpay a fixed amount each month, you can establish a standing order.

FAQs

Q – Should I overpay my mortgage each month or ask my lender to officially reduce the term?

A – When faced with the option, the general recommendation is to opt for overpaying if possible.

Reducing the mortgage term appears to be a logical choice as well, achieving similar outcomes to overpaying—both strategies involve higher monthly payments, reduced interest costs, and an earlier payoff of the mortgage.

Nevertheless, committing to a plan with elevated monthly payments can be risky. In the event of an unexpected income disruption or if you are on a variable rate and interest rates increase, you might find yourself in financial difficulty. On the other hand, with overpayments, you have the flexibility to cease them if needed, offering more leeway in times of financial strain.

Q – Can you overpay an offset mortgage?

A – Yes, typically you can, but it’s worth considering carefully since you might already be somewhat overpaying with your offset mortgage.

An offset mortgage operates by keeping your mortgage debt and savings separate but within the same financial institution. The key feature is that your savings are used to reduce, or “offset,” the interest charged on your mortgage.

For instance, if you have a £150,000 mortgage and £15,000 in savings, you will only be charged interest on the remaining £135,000.

The crucial difference between offsetting and overpaying is that with an overpayment, the extra funds are permanently applied to your mortgage balance and are no longer accessible if you need them. Conversely, with an offset mortgage, your savings can be withdrawn at any time, though this will affect the amount of interest you save on your mortgage.

Therefore, it’s important to weigh the pros and cons before deciding to convert your offset into an overpayment.

Q – Does it matter when I make overpayment(s)?

A – Typically, most mortgages accrue interest on a daily basis. This means that if you make an extra payment, your interest for the following month will be based on your reduced balance—this is advantageous if you’re making additional payments.

However, if your mortgage is older (more than 10 years), you might need to be more attentive when making extra payments. Older mortgages may calculate interest monthly, quarterly, or even annually. To determine the specific details for your loan, it’s a good idea to review your mortgage agreement or contact your lender directly.

When interest is not calculated daily, timing your overpayments becomes crucial. For mortgages where interest is calculated monthly or annually, the timing of your additional payments is particularly important for maximizing benefits.

Mortgage overpayments will only count AFTER the calculation’s made. Put it in at the wrong time and you’ll miss out.

An extreme example should help to simplify this…

In this scenario, if you miss the annual review date, it’s advisable to place the funds in a high-interest cash ISA or an easy-access savings account to accrue interest until you’re ready. Then, plan to make the mortgage overpayments a few days prior to the calculation date.

For those with a significant lump sum to overpay, check with your mortgage lender to see if they can perform an interim calculation, even if it’s not the scheduled review date. Many lenders will accommodate this, provided the overpayment is at least £500-£1,000.

This advice also applies to interest-only mortgages. When you make overpayments, lenders are expected to apply these funds to reduce the outstanding balance, which should lower your monthly interest payments from the next review date. If your overpayment substantially reduces the debt, transitioning to a repayment mortgage might become a viable and affordable option.

Q – Would I do better investing rather than saving?

A – Now we venture into ‘interest’-ing territory (pun intended). Investing involves allocating your money into financial products that carry some level of risk, with the hope that your investment will grow at a faster rate. However, there’s always the possibility of losing money as well.

While our calculator indicates that finding a savings account that outperforms the benefits of overpaying a mortgage can be challenging, investing presents a different scenario.

Top-performing investments can yield significantly more than 10% annually, but conversely, poorly performing investments can result in substantial financial losses. This applies to various investment avenues, such as contributing to your pension or purchasing additional property (perhaps as a buy-to-let) instead of focusing on paying down your mortgage. Success in these ventures means potential gains, while failure could lead to financial setbacks. There are no guarantees in investing.

We don’t provide specific investment recommendations because there’s no definitive right or wrong choice—only ways to minimize costs when purchasing investments (refer to Share Dealing Essentials and Stocks and Shares ISAs). Therefore, we won’t delve deeper into this topic here. For personalized guidance, consider consulting an independent financial advisor.

That said, investing is not inherently flawed. When executed properly, it can be highly lucrative, as long as you’re aware of the risks involved.

To achieve investment returns comparable to paying off your mortgage, you generally need to engage in higher-risk investments—whereas making extra mortgage payments ensures a guaranteed return.

Looking for more mortgage help?

We’ve got lots of other helpful guides and tools, including:

• Remortgage guide – Free PDF guide.
• Cheap mortgage finding – How to find the top deal for you.
• Mortgage best buys – Find your top mortgage deals.