If you’re asking, ‘Should I overpay my mortgage?’, then you’ve got a Wallet Savvy mindset. But before you do, financial expert Michael Barton highlights some key considerations to make first.
During my time as a personal financial advisor, one of the questions I was often asked was if a client should overpay on their mortgage.
Doing so will reduce how long it takes to repay what you have borrowed. It will also cut the amount of interest you pay. You could save thousands, and become financially independent, faster.
The decision would seem like a no-brainer, but it’s not always clear cut. There are circumstances in which overpaying your mortgage could be a big mistake that could cost you dearly instead of accelerating you toward your financial goals.
30-Second Summary
Overpaying your mortgage could save you thousands in interest and help you become financially independent faster. It can also free up thousands each year after you have repaid your mortgage to do with what you please.
However, before deciding to overpay your mortgage, you should give consideration to some key questions:
Have you an effective emergency fund?
Have you repaid high-interest debts?
Do your mortgage terms allow for overpayments without penalties?
You’ll also need to consider if investing your money instead might deliver better returns. Get the decision right, and overpaying your mortgage could accelerate you to financial freedom.
What Is Mortgage Overpayment?
Mortgage overpayment is simply paying more than the amount required by the terms of your mortgage. You can do this by making extra payments each month, or by irregular payments – for example, when you get a bonus at work.
When you pay more than is required into your mortgage account, your overpayment comes off the amount of capital you owe. In turn, this reduces the amount of interest you pay (because interest is calculated on the outstanding debt).
You’ll shorten the time it takes to pay off your mortgage, and therefore also reduce the amount of interest you pay.
There are other financial consequences that may not be quite so obvious.
First, because you are reducing the capital you owe on your mortgage, the equity you have builds up faster. Should you find yourself needing to remortgage in the future, the extra equity you have in your home should make it easier to do so.
Second, this higher home equity could make it easier to find cheaper mortgage deals – thus saving you even more money. This is because the loan to value (LTV) is smaller, and the smaller the LTV, the lower the interest rate you are likely to be charged.
Another hidden benefit is that, by paying off your mortgage earlier, you’ll have more money to do other things with after your mortgage has been repaid. I’ll run through how this could benefit you later in this article.
How Much Could You Save By Overpaying Your Mortgage?
The amount you could save depends on several factors:
- The amount of your mortgage
- Your mortgage interest rate
- How much you are overpaying by
- How long you overpay for
- The frequency of your overpayments
Let’s say you have a £200,000 repayment mortgage, with an interest rate of 5% and a repayment term of 25 years. Overpaying by £50, £100, and £200 each month would have the following effect:
| No Overpayment | Overpay By £50/month | Overpay By £100/month | Overpay By £200/month | |
|---|---|---|---|---|
| Monthly Mortgage Payment | £1,169.18 | £1,219.18 | £1,269.18 | £1,369.18 |
| Term | 25 years | 23 years, 1 month | 21 years, 6 months | 18 years, 10 months |
| Total Interest Paid | £150,754.02 | £137,339.72 | £126,248.62 | £108,911.46 |
| Total Paid | £350,754.02 | £337,339.72 | £326,248.62 | £308,911.46 |
| Overpayments Total | – | £13,800.00 | £25,700.00 | £45,000.00 |
| Total Interest Saved | – | £13,414.30 | £24,505,40 | £41,842.56 |
Pretty impressive, eh? It gets even better.
The Real Benefit Of Repaying Your Mortgage Early
By overpaying your mortgage, you will become financially independent faster. What does this really mean?
Using our example above, if you overpay by £200 per month, you’ll reduce your original mortgage term of 25 years by six years and two months. That’s six whole years and two months where you can start keeping your money for yourself.
Now, let’s suppose that you redirect what you would have been paying on your mortgage into a SIPP (there will be contribution rules to follow, but this is for illustrative purposes only).
You’ll pay a net amount of £1,369.18 per month into a SIPP for that six years and two months (74 months), and benefit from tax relief on your contributions. If you pay tax at 20%, tax relief will gross up your pension contribution to £1,711.47 per month.
Over the 74 months, you would contribute a total of £126,649.17 into your pension. Compare that to the average UK pension pot – it’s more than most people have saved in a pension during their whole working life!
Add in investment growth, and the figures could be even better (depending upon fund performance).
Excited about making overpayments to your mortgage? You should be. But before you rush to make them, there are some considerations to make first.
Are Mortgage Overpayments Right For You?
Before you start making overpayments on your mortgage, you’ll need to make sure you can afford to do so – sensible budget planning is crucial, and financial stability is critical. You mustn’t jeopardise your overarching financial goals or your current financial wellbeing.
Here are three questions to answer:
1. Are You Maintaining An Effective Emergency Fund?
An emergency fund is your safety net in case of unforeseen circumstances. It’s the cushion that prevents you falling into financial crisis.
With a properly funded and maintained emergency fund, you are much less likely to need to borrow money on expensive credit terms to get over what would otherwise be a financial inconvenience, not a catastrophe.
2. Should You Repay Other Debts First?
I class a mortgage as a good debt. It’s among the cheapest forms of borrowing, puts a roof over your head, and (hopefully) the money you borrow is invested in an appreciating asset.
If you have bad debts that charge high interest rates – credit cards, for example – it could be more beneficial to pay these off first, because you’ll be saving more in interest payments.
3. Will You Incur Penalties On Overpayments?
Before making overpayments, make sure you read the terms of your mortgage. Some mortgages won’t allow you to make an overpayment, or will limit how much you can overpay.
Break these terms (if they exist) and you could face hefty penalty charges that might outweigh any benefits of overpaying.
Final Thoughts
Before you decide to overpay on your mortgage, you should carefully consider your personal situation and financial wellbeing. The potential benefits are extremely tempting, but you should first ensure your financial stability – that you have an effective emergency fund saved, have repaid expensive debts, and that you can afford to make overpayments.
You should also consider if your money might work harder for you by investing it. You’ll need to consider the pros and cons of saving rather than paying off your mortgage, such as potential investment returns in place of guaranteed interest savings when overpaying on your mortgage.
When you understand all the implications, pros and cons of overpaying on your mortgage, and have weighed doing so against the alternatives, you’ll make the right decision – a decision that will help you stride toward financial freedom.