Is overpaying your mortgage the right choice for you? The pros and cons

young couple shake hands with mortgage brokerWith the world almost grinding to a halt over the last 18 months and national lockdowns keeping everyone in their homes, many Brits have managed to save a little extra money.

The Bank of England estimates that households built up more than an extra £125 billion in savings from March 2020 to November 2020, and this increased to over £200 billion by June 2021.

If you’ve found yourself with a little more cash than usual, you may be wondering how to use it effectively.

One way to do this could be to overpay your mortgage, but is it the right decision for you? Read on to find out the pros and cons of doing so, and whether it could benefit you given your own financial situation.

3 potential benefits of overpaying your mortgage

Overpaying could reduce the interest you pay

By increasing your monthly mortgage payment, or paying a large amount in one lump sum, you could shave a few years off your mortgage and reduce the interest you pay.

The tools you need to calculate how much money you could save are freely accessible online. Both MoneySavingExpert and Nationwide have their own mortgage calculators, which can show you exactly how much you may be able to save.

Imagine you take out a mortgage of £200,000 with a term of 25 years, and an interest rate of 3%. If you were to make a one-off £10,000 payment, and keep your monthly repayments the same, you could save a total of £10,549 in interest alone by the end of your term, and finish paying your mortgage 21 months early.

Alternatively, if you were to increase your monthly payments by £100, you could save £12,429 in interest and finish paying your mortgage almost three-and-a-half years earlier. 

Overpaying will leave you debt-free sooner

One of the stresses of having a mortgage is that you are in debt. Not only is this a strain on your finances, but it could be a strain on your mental health, too.

Being debt-free allows you to dedicate more money towards other financial goals and lifts the weight of your mortgage payment off your shoulders. As well as the psychological benefit of the security of owning your own home, you could be saving hundreds of pounds a month once it is finally paid off.

This money could go towards your pension, which may give you the opportunity to live your later years as you would like. Or perhaps you could invest it into the stock market, giving your savings the potential to grow long into the future.

Plus, just the knowledge that you are free of what will most likely be the biggest financial commitment of your life can do wonders for your mental health, no matter what you use your extra money for.

It could be the most effective use of your savings

In an environment of record-low interest rates, it could make sense to overpay your mortgage rather than letting your cash stagnate in a savings account. If you’re only getting a very small return on your savings, then it is likely that you will be paying a higher interest rate on the borrowing.

As of 14 September 2021, financial analysts Moneyfacts report that the top-paying easy-access savings account offers just 0.6% interest. Meanwhile, you might be paying 2% or more on your mortgage.

In this case, you could be better off using your cash, which is earning very little, to repay the debt that incurs a higher interest rate.

There are some circumstances in which paying off your mortgage may not be worth it

Early repayment charges might cancel out the benefits

Before you overpay on your mortgage, you need to establish whether your lender will levy an early repayment charge (ERC). If you have a fixed- or tracker-rate mortgage, there may be ERCs to pay if you want to pay off some or all your mortgage before your deal expires.

If you do end up paying an ERC it may defeat the point of overpaying in the first place.

Typically, mortgage providers will let you overpay up to 10% of your outstanding mortgage balance each year. Before you make any overpayments make sure you research and understand the rules around your mortgage and ERCs.

It may not be affordable

You should always have an emergency fund on hand before you even think about overpaying your mortgage. An emergency fund should consist of three to six months’ worth of essential spending to cover you in the event of unexpected payments or a sudden loss of income.

If you’ve paid a lump sum to your mortgage, or you’ve increased your mortgage payments, these overpayments can be difficult to get back if you suddenly need them.

So, always make sure you’re comfortable in making any overpayment before you make that commitment. If you’re not sure, get in touch with us and we can consider your options.

You may have other high-interest debts

You may want to consider alternatives to overpaying your mortgage if you have other debts that charge you more interest.

For example, while you may be paying 2% to 3% interest on your mortgage, you could be paying 20% or 25% interest on your credit card.

It is usually the case that you will save the most money by paying off the higher interest debt first. This way, once it is paid off, it will no longer be accruing a large amount extra each month, and the money you were paying towards it can go towards other financial goals.

If you’re unsure which debt to pay off first, make sure you speak to us for advice.

Work with us

If you’re not sure whether overpaying is the right decision for you, come and work with us; we can help work out what is best for you and your financial goals.

Email [email protected] or call 0131 339 2281 to find out more about how we could help you.

Please note

Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.

Buy-to-let (pure) and commercial mortgages are not regulated by the FCA.

Think carefully before securing other debts against your home.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

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