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Should you make mortgage overpayments?

Making mortgage overpayments can save you thousands of pounds in interest, but there are some potential fees to consider before doing so.

Essentially, by overpaying on your mortgage, you will be paying off your debt quicker, and the amount you pay extra won’t be subject to interest.

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One way to look at mortgage overpayments is to use the money you would normally put away into a savings account on overpaying instead.

If savings rates are low then you could potentially save much more money by using your saved up cash to avoid paying extra interest on your mortgage, instead of leaving it in an account to accumulate very little interest.

What is a mortgage overpayment?

A mortgage overpayment, like it sounds, is paying slightly more than you are required to pay on your monthly mortgage repayment.

The extra amount you pay is not subject to the interest rate on your mortgage and could save you thousands of pounds over the long term.

Most mortgage providers will let you make mortgage overpayments at no extra cost by up to around 10% of the mortgage value per year, but this is something you should double check first.

However, if you go over the set amount as outlined in the mortgage terms and conditions, then you will be charged an early repayment penalty fee. This will usually be a percentage on the amount you paid over the overpayment threshold.

For example, if you overpay £12,000 which is an overpayment of 12% and your mortgage only permits up to 10% of the mortgage value, then you are most likely to be charged a percentage on the overpay (£2,000). This fee can be anywhere between 3% and 10%.

Other mortgage providers may have other fees and rules for overpaying, so always check the terms and conditions of your deal.

How much could you save by making overpayments?

The best way to calculate the savings you would make by making mortgage overpayments is to calculate how much the interest on your debt would cost versus how much the money you have saved will accrue in interest.

For example, say you have a mortgage debt of £5,000 that you want to get rid of by overpaying. And say the interest rate on your mortgage over the next 12 months is fixed at 3%, meaning you have £200 of interest to pay off.

Now, take a look at your savings. Let’s say you have £5,000 in a savings account, with an interest rate of 1.3% over the next 12 months. It will grow by £65.

Instead of putting that money into a savings account, you can use it to overpay your mortgage and cut the amount you would pay in interest, leaving you £135 better off.

How to calculate how much money you could save by making mortgage overpayments:

  • Check the interest you are paying on your mortgage over the course of the next year
  • Check the interest on your savings account over the next year
  • If your mortgage interest rate is higher, then you are likely to be better off
  • Subtract the total you would pay (on the mortgage) from what you would save (on the savings account)
  • Double check the terms of making mortgage overpayments (it’s usually up to 10% of the mortgage value within a year, but this isn’t a rule)

Going over the threshold for making mortgage overpayments can cost you far more than any savings you made, so be careful and make sure you have done your calculations correctly.

Can you make overpayments on any mortgage?

Almost all mortgages will allow customers to make overpayments. Double check this in the mortgage provider’s terms and conditions though.

Each mortgage provider will have their own rules on how much you can overpay, and have different penalty amounts for overpaying too much.

When should you make overpayments?

You should make overpayments if you have enough money in the bank to put away into a savings account.

But most importantly, you should only make mortgage overpayments if the savings rates are lower than the mortgage interest rate you are paying.

If savings rates are higher, then putting your money in a savings account will make you more money.

You should also only consider making overpayments if you have enough of an ’emergency’ fund in the bank. If you lost your job or had a change of circumstances that you needed extra money for, you don’t want to have used all your savings on repaying your mortgage.

With a savings account you’re likely to be able to pull the money back out again in case of an emergency. However, if you’ve put your savings towards overpaying your mortgage, the money is gone (unless your mortgage has flexible features such as an offset mortgage or one with a ‘borrow back’ option – read more below under ‘Mortgage overpayments vs offset mortgages’).

It may save you hundreds, if not thousands of pounds in interest, but having back-up savings will give you some peace of mind.

Overpayments vs savings and investments

If you have extra money left over after you make your monthly mortgage repayments, then you may want to do something with it to help it grow and leave you and your family better off.

There are risks with certain savings and investments – generally, those that offer better interest rates carry a higher risk. But, there is also a risk of overpaying on your mortgage, even if the savings are higher than that of a savings account – namely, that you can’t get the money back.

Generally, if the savings are higher than your mortgage interest rate, then always put your money into a savings account instead of making mortgage overpayments.

Investments are often a bigger risk, so you may want to speak to an independent financial adviser first, or consider putting away a smaller amount and using the rest on making mortgage overpayments or putting it into a cash ISA.

However, if you have an offset mortgage or a mortgage with a borrow back facility, then making mortgage overpayments may not be as risky, as you will still be able to get your money back (albeit with some drawbacks).

Mortgage overpayments vs offset mortgages

With some of the more flexible mortgages on the market, such as offset mortgages, which are linked to your savings, you can overpay and borrow the money back without penalty if you need the cash again.

This can be a less risky option if you don’t have any spare cash after you make your mortgage overpayments.

However, offset mortgages and other more flexible arrangements tend to have a higher mortgage interest rate than others on the market.

Offset mortgages are usually best if you are using your savings as mortgage overpayments, so if you plan to regularly dip into your savings, you won’t be making as much of an impact on reducing your monthly mortgage repayments.

Read more…

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