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Should I overpay my mortgage?

Should you use savings to overpay?

Should I overpay my mortgage with my savings?With savings rates at an all-time low, many home-owning savers might be thinking overpaying on their mortgage is a no-brainer.

But there are spanners in the works such as repayment penalties, how you keep emergency funds, and more. This guide helps you decide if it's right for you.

Important checks before you start

Before you begin, you need to establish a few key facts. Without them, you can't make this substantial financial decision.

Are your savings rates as high as possible?

This isn't a question of whether overpaying your mortgage beats your current savings. Instead, it must be 'does repaying my mortgage beat the highest paying savings available?'.

Many people are earning pitiful rates, and assume they can't improve them. Yet better deals are often available. So if you haven't already, check the Top Savings Accounts and Top Cash NISA guides for all the best rates.

You needn't switch to them right now, as overpaying your mortgage may win out. But at least know what's on offer, and compare against that to calculate the right option.

Would you face overpayment penalties?

Some lenders punish those who try to repay their mortgage quicker than agreed. This is especially common if you have a special offer fixed, tracker or discounted deal (see the free Remortgage Guide for details).

This is because lenders want you to stick with them once the cheap rate ends, as at that point their rates shoot up. This means it's not in their interest to let you repay the mortgage more quickly, because the longer it takes you to repay, the more they earn.

Thankfully, many allow you to overpay by up to 10% of the outstanding mortgage debt each year without penalties. But you must check with your lender, as any substantive extra costs are likely to outweigh the gains from overpaying the mortgage.

It's also worth checking your lender won't either reduce your normal payments (meaning you're not overpaying) or reduce the term of your mortgage (effectively locking you in to the higher payments). If they'll do either of these, it might not be worth overpaying after all. Read Martin's blog on why you should overpay rather than reduce your term.

Do you have other debts, such as credit cards or loans?

A crucial rule of debt repayments is: clear the most expensive debts first. Do so and the interest doesn't build up as quickly, saving you cash and giving you more chance of clearing debts earlier. Therefore, as a rule of thumb...

Clear credit cards and loans before overpaying your mortgage, as they're usually more expensive.

Yet as with any rule of thumb, there are exceptions. Click all of the following that apply...

You're looking to get a remortgage deal

You have outstanding student loans

You are a 0% credit card tart

You aren't allowed to overpay a loan

From this point on, we'll assume you're free of all other more expensive debts and have spare cash.

Do you have a sufficient emergency fund?

Good old-fashioned budgeting logic says it's always worthwhile having a cash emergency fund. While for people with expensive card and loan debts we generally disagree (see Use Savings To Repay Debts?), for those who are debt-free, apart from a mortgage, this is a good idea.

Overpay most mortgages and the cash is gone. So if the roof leaks or boiler bursts you may be forced to use expensive credit cards instead. Your earlier overpayments won't stop lenders charging you for being in arrears if you miss monthly repayments (see Mortgage Arrears Help).

So it's always a good idea to keep an emergency fund in savings - three to six months' worth of cash is a good guide, enough to live on if you lost your job or had other issues. If you're thinking of using newly arriving extra income (such as a pay rise) to overpay your mortgage, then build up an emergency fund first. As a minimum...

Put enough aside to cover mortgage repayments
for at least six months.

This applies even if the calculator shows you'd be better off overpaying your mortgage. It's what's known as 'a premium for liquidity'. In other words, it's sacrificing some interest for easy access to cash when needed.

The exception to this is for those with flexible or current account mortgages.

Can you cut the cost of your mortgage?

It's worth checking to see if your mortgage is over-expensive before making the decision.

If you can get a cheaper mortgage, it may change the result. Take a quick look at our Mortgage Best Buys tool to see what rates are available at your current LTV.

Find the best buy mortgages

If you're ready to get a mortgage, tell our Mortgage Best Buys tool what you want, and it'll speedily find the top deals for you.

Ready to remortgage?

If you want to change mortgage, this free guide has tips on when you should & shouldn’t remortgage and how to grab top deals.

Ready to get a mortgage?

Want to get on that first rung? Our free guide helps you find the cheapest mortgage and boost your chances of getting accepted.

Thinking of buying to let?

Property investing newbie or an old hand wanting the top deal? Our free guide outlines all you need to know about buy-to-let.

Paying off a mortgage versus saving

Before getting on to mortgages specifically, it's important to understand the basic principle of how all debt and savings interact. Borrowing and saving are two sides of the same coin...

The difference is the amount saving pays us is usually far less than the amount borrowing charges us, that's one way banks make profit (see the Should I Repay Debts With Savings? guide).

£1,000 debt on a credit card at 18%,
The interest cost is: £180

£1000 savings at 2% after tax,
The interest earned is: £20


Pay off the debt with the savings and you are £160 a year better off!

This all seems very simple with credit cards, but it can seem much more complex when it comes to home loans, so let me spell it out...

A mortgage is a debt. It may have special properties, but it is a debt just like any other.

So here's the same calculation as above, this time for a mortgage...

£10,000 mortgage debt at 5%,
Annual interest cost is: £500

£10,000 savings at 2% after tax,
Annual interest earned is: £200


Pay off the debt with the savings and you are £300 a year better off!

So here while the difference between the cost of the mortgage and the gain from Top Savings is smaller than with other debts, it's still significant. Plus this is at basic-rate tax, those paying higher or even top rate will find the gap much bigger. Therefore we get a very simple rule...

If your mortgage rate's higher than after-tax savings interest you'll profit by overpaying it rather than building savings.

Is it worth overpaying my mortgage? Take our test

To really cement this, start to think of overpaying your mortgage as a form of saving. Take repaying a 5% mortgage...

To earn £500 a year after tax on £10,000, a basic-rate taxpayer needs an account paying 6.25%, higher rate 8.33% & top rate 9.1%

These are phenomenal, gobsmacking, unheard-of amounts that you simply can't get safely in any normal account, which shows just how profitable overpaying a mortgage can be.

Tool: Should I overpay my mortgage with savings?

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Once the calculator tells you what savings rate you need, check out the Top Savings Account or Top Cash NISA guides to see what's currently available.

For the vast majority of people, making extra mortgage repayments wins (though as noted earlier, always ensure you've used your cash NISA allowance first).

How much will I gain by overpaying?

Working out the savings made by overpaying your mortgage isn't simply a matter of chopping the lump sum repayment from your balance. It cuts future interest and hopefully will mean you're mortgage-free much earlier.

Time mortgage overpayments correctly

Mortgage repayment frequencyMortgage companies have four ways of calculating the interest you owe - daily, monthly, quarterly or annually. Check your mortgage to see which it is - though thankfully the majority of new mortgages are on daily interest, which is better for you as an overpaying borrower.

The less frequent their calculations, the more important it is to plan the timing of your overpayments. With monthly, and especially annually, calculated mortgages, it's crucial to time any extra repayments correctly for one simple reason.

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...
Done wrongly Done right
Mortgage type Annually calculated Annually calculated
Mortgage rate 5% interest 5% interest
Calculation date 2nd May 2nd May
Amount overpaid £10,000 £10,000
Overpayment date 3rd May 1st May
Interest reduction over year Nothing £500

In this example, if you missed the annual date you'd be better off putting the money in a top Cash NISA or Instant Access savings so you're earning interest in the meantime. Then arrange to make the mortgage overpayments a few days before the calculation is made.

If you have a substantial lump sum to overpay, ask the mortgage company if it will automatically make a calculation, even if it's not the calculation date. Many will do this for you, though you may need to be overpaying a minimum of around £500 - £1,000.

The above all applies to interest-only mortgages too - if you make overpayments lenders should apply this to the outstanding debt, and cut your monthly interest payments from the next calculation date. If your overpayment significantly dents the debt, it may make moving onto a repayment mortgage an affordable option.

Key alternatives to overpaying

If it all adds up that overpaying is the right option for you, there are a couple of other things worth considering flirting with before you take the plunge. We're not saying "these are better" - but we'd be a little remiss if we didn't at least nod to them.