Is overpaying your mortgage always worth it? Or are there times when it pays to stick to your agreed repayment schedule?
While overpaying your mortgage can save thousands in interest and take years off the term, it isn’t necessarily right for everyone. Here’s a brief look at the reasons why you’d want to make overpayments, and why it might not be such a good idea.
What is a mortgage overpayment?
Making an overpayment means paying your mortgage provider a larger amount than you’re supposed to pay. You can do this in one of two ways:
1) by making a one-time lump sum payment
2) by adjusting your monthly repayments so that they’re always greater than the specified amount
Why overpay your mortgage?
Making overpayments has three main benefits: it can help you pay off your mortgage sooner, it can drastically lower the amount of interest you have to pay and it can give you increased flexibility.
It’ll take you less time to pay off your mortgage
The extra amount you ‘overpay’ goes entirely towards repaying the mortgage itself, not on any interest you owe. This applies even if you’re on a repayment mortgage. This means you could shorten the amount of time you need to repay the mortgage in full.
You can lower the amount of interest you have to pay
Since overpayments pay down the mortgage itself, you could dramatically cut down the amount of interest you have to pay. The reason for this is because the interest you’re charged is calculated on the outstanding amount you owe. If your outstanding amount is lower, the amount of interest calculated will be lower too.
As the amount outstanding on your mortgage starts going down, the interest due will gradually go down, too. So, over time, more of your monthly repayment will go towards paying off the mortgage itself.
Overpayments put you ahead of schedule by covering the cost of specified repayments for many months. This opens up the option of underpaying down the line.
Not all lenders will allow you to do this, so check first.
When should I overpay?
Depending on your lender, interest on your mortgage may be calculated daily, monthly, quarterly or annually.
If interest is calculated daily or monthly, the timing of your overpayments doesn’t matter. You’ll save money instantly. But if interest is only calculated periodically, you should time your overpayment to coincide with the calculation, or you won’t make any savings.
Example: Your lender calculates interest annually every 21st June. To save on interest in the coming year, you have to make the overpayment before that date.
When NOT to make mortgage overpayments
Overpaying your mortgage can sound like a no brainer. But in reality, whether it makes sense depends on your personal situation. Sometimes, it may be better to stick to the agreed schedule and not overpay at all. Here’s why:
Your lender has restrictions
Not all lenders allow overpayments. In fact, some actively discourage them.
Mortgage lenders make money by charging interest. Overpayments mean less interest, which means your lender makes less money. So, some lenders charge hefty fees to dissuade you.
Overpayment fees can be as high as 5% of the overpaid amount. You may find that this cost cancels out or exceeds the benefits of overpaying. Check your mortgage’s terms and conditions carefully and do the maths before you decide.
You have other, more expensive debts
While most of your other debts are probably smaller than your mortgage (well, at least we hope so), they might still be more expensive.
Credit card debts, overdrafts and unsecured loans usually attract higher interest rates than mortgages. It might be best to pay these debts off first, before you consider making any overpayments.
You don’t have anything saved up
While chipping away at your biggest debt is a sensible idea, it’s like putting all your eggs (savings) in one basket.
Unless you sell your house, you won’t be able to get back any of the money you overpay on your mortgage. So you may want to make sure you have enough liquid cash to tide you over in case of emergencies before you commit this to paying off your mortgage.
You may also want to think about retirement (even if it seems a long way off). If the amount of extra cash you have is limited, investing in a pension plan may make more sense than shaving a few years off your mortgage, especially if you’ve got an employer making contributions this as well.