Should I overpay my mortgage?
It's a question of whether you save, or whether you overpay your mortgage
Interest rates on both mortgages and savings are on the way up, so it's tough to choose whether your money's better in savings, or put towards paying down your mortgage. Overpaying your mortgage could save you £10,000s in interest – and can also soften the blow of current rate rises – but it's not right for everyone. This guide helps you decide.
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Overpaying often wins – but not for all
Get it right and overpaying your mortgage can be a huge cash boost, because...
- You'll be eating into the debt you've built up from buying a home, meaning you pay it off quicker.
- You don't pay interest on the amount you overpay.
- The money you'd save on interest often (but not always these days) beats the returns possible by putting it in savings.
Overpaying means you make the same gain as saving at your mortgage rate. If you've a 4% mortgage, you'd need savings paying at least this. And, if you've used up your personal savings allowance, you need savings paying even more; higher-rate taxpayers would need to earn 6.5+%.
Here's a real-life example of someone who's saved big by overpaying their mortgage:
Started making overpayments on my mortgage seven years ago. Saved £18,600 in interest and paid up eight years and three months early. So my ex-mortgage payment can now go towards a fantastic retirement pot.
Check 1: Can you overpay without penalty? Most can overpay 10% per year, but get it wrong and you risk £1,000s in fees
Most lenders allow you to pay 10% of your mortgage balance as an overpayment per year if you're still in your introductory fixed or discount period.
If you're on a tracker mortgage, or you're beyond that intro deal and paying your lender's standard variable rate (SVR), you can usually overpay by as much as you want. But many SVRs are expensive, so if on one it's best to check if you can save by remortgaging, rather than only overpaying.
However, the 10% rule is not universal. Some lenders punish those who try to overpay by more (see the What type of mortgage to choose guide for details).
Fees for paying too much are typically between 1% and 5% of the amount overpaid depending on your mortgage, though the fee you pay usually decreases the closer you are to the end of the fixed or discount period. The amount you pay as a penalty will vary between mortgage deals.
Say you've a five-year fix on a £150,000 mortgage and decide to overpay a lump sum two years into the deal. However, instead of sticking to the 10% (£15,000) limit free of penalty, you overpay £20,000 instead.
This means you must pay a 3% penalty on the extra £5,000 overpayment – £150. However, this 'percentage left on loan' rule of thumb is very rough, so always double-check with your lender.
The reason for such harsh penalties is because lenders want you to stick with them once the cheap rate ends and because they've also budgeted to earn a certain amount of interest from you during the mortgage deal, and overpaying means they'll get less.
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 high-interest credit cards and loans before overpaying your mortgage, as they're usually more expensive.
There are a few debts you probably shouldn't pay off before your overpaying your mortgage, including these....
This specifically refers to official loans from the Student Loans Company.
Students who started university in 2011 or before, plus Northern Irish & Scottish students starting any time
For students who started university or college in 2011 or before, interest is set at the lower of base rate plus one percentage point, or the rate of inflation (RPI), making it the cheapest possible long-term debt. It's possible, if inflation is high and interest rates are low, you may have a mortgage that's cheaper than the student loan but over the long term, that's unlikely.
Plus, unless you're earning over a set threshold (the exact amount depends on whether you started before or after 1998) you won't have to make monthly loan repayments anyway. Due to the odd nature of these loans and how you repay them, you should prioritise your mortgage over repaying these.
Students who started university in 2012+ in England & Wales
For these students, interest is charged at the rate of inflation plus 3% while you're studying, then on a sliding scale from RPI to RPI+3% depending on how much you earn. So, for most students this applies to, it's actually likely that you'll pay a higher interest rate on your student loan that you will on your mortgage, at least at current rates.
However, that doesn't automatically mean that you should pay your loan off above overpaying your mortgage. Whether you should overpay your loan depends on whether you're likely to pay it all back before it's wiped in 30 years' time. Many won't, and if all your student loan overpayments are doing is depriving you of extra cash now, then it's not worth it.
For more information see Should I repay my student loans?
It's arguable that those who are financially savvy, with top credit scores, strict organisation and timekeeping who disloyally shift from 0% credit deal to 0% deal (see the best balance transfers guide) should also pay their mortgage off before their credit cards, as even with balance transfer fees they're cheaper than most mortgages.
However, this strategy should only really be adopted by the extremely financially competent. For anyone who doesn't trust themselves to stay disciplined, it's generally best to clear card debts first, even at a short-term 0%
I often say it's worthwhile having a cash emergency fund for those who are debt-free – apart from their mortgage (for people with expensive cards and loans debts I generally say you should Use savings to repay debts?).
Yet, when you overpay most mortgages the cash is gone. So if you've an emergency (leaking roof or redundancy, not new shoes) and you'd overpaid with all spare cash, you could be forced to borrow again instead. Your earlier overpayments may not 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 a top savings account – I always say three to six months' worth of cash is a good guide, enough to live on if you lost your job, for example. 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.
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.
Mortgages with flexible features (including offset, current account mortgages or those with a 'borrow-back' facility) allow you to overpay and borrow the money back. So you can overpay the mortgage, then withdraw cash without penalty if you need it again. If you have one of these, there's no problem putting all spare cash in the mortgage.
It can be used like a high-rate savings account as you're effectively saving at your mortgage rate but without paying tax. That said, as mentioned earlier, this is less beneficial as all savings accounts give you all the interest without tax taken off thanks to the personal savings allowance.
This example shows how it can work:
On a £150,000, 25-year mortgage, offsetting £25,000 of savings could mean you pay off your mortgage one year and 10 months early, and save £3,350 in interest, while still having access to your savings if needed.
Don't misread this as saying everyone should go for one of these mortgages. The problem is their interest rates are usually higher than standard mortgages', and for many the extra cost of the mortgage debt more than outweighs the gain on savings.
But some of these flexible features are not well publicised so check with your lender if you have this option.
Check 4: Are your savings rates as high as possible?
Before you say "my interest rate is crap, so I'll overpay my mortgage", you need to check if you can boost the rate you're getting. It's worth knowing 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 earn pitiful rates, and assume they can't improve them. Yet better deals are increasingly available – that's because rates are slowly improving at the moment. So if you haven't already, check the Top Savings Accounts and Top Cash ISA 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.
Overpaying vs saving – which wins?
If you've got this far, I'm going to assume you're debt free (or your debts are at 0%, or cheaper than your mortgage), you have an emergency fund, you know what the best rate you can get on your savings is, and have a mortgage that allows some level of penalty-free overpayment.
So now you need to check whether you should overpay your mortgage or save the cash elsewhere. Overpaying your mortgage is all about this key decision. And what you should do depends on what makes financial sense. The simple rule of thumb is:
If you can get a higher rate on your savings than you pay on your mortgage, saving wins. But if your mortgage rate is more than your savings rate, then it makes sense to overpay.
A simplified example should help...
If you've £10,000 mortgage debt at 4%,
Annual interest cost is: £400
If you have £10,000 savings at 3%,
Annual interest earned is: £300
Pay off the mortgage with the savings and you are £100 a year better off. We've not included tax deductions in the example as the new personal savings allowance means most people don't pay tax on bank interest received.
Take my test to see if you should save or overpay your mortgage
I've built a calculator which tells you how much interest you would need to get on a savings account to beat overpaying your mortgage. Just enter your mortgage rate and select your tax rate to find your magic number (if all interest's covered by the personal savings allowance, as it will be for 95% of people, select the PSA button)...
Calculate how much you'll save by overpaying your mortgage
Overpaying can save you £10,000s over the lifetime of a mortgage. And, as the table shows, overpayments don't have to be big bucks. Even £50 or £100 a month can dramatically reduce the interest you pay, shorten your mortgage term, and – with interest rates still relatively low – will normally overshadow savings interest...
|£50||Two years, five months||£9,508||£5,840|
|£100||Four years, four months||£17,082||£9,585|
|£200||Seven years, five months||£28,429||£13,400|
|£500||12 years, eight months||£47,457||£15,630|
|£1,000||16 years, nine months||£61,285||£13,450|
|(1) The mortgage has a 25-year term. (2) Savings are pre-tax and stop as soon as the mortgage is paid off to make the comparison fair.|
You can save such large sums of interest by overpaying because overpaying doesn't just get rid of the debt – it gets rid of the interest you would have paid on that bit of borrowing in the future too.
Use our Overpayment calculator to reveal your savings. Remember, you also need to work out how much interest keeping your cash in savings would earn over the same time period, and subtract this from your profit for overpaying.
How do I overpay my mortgage?
If you've done all the sums and you think overpaying your mortgage is the right decision, then the simplest way, at least the first time you do it, is to give your lender a call. This way, you can check it's allowed, and also ensure your overpayment(s) are used the right way.
When you make an overpayment, your lender may offer you two options: either to reduce next month's payment by the amount you've overpaid, or to keep payments the same and reduce your mortgage term instead.
This is something to watch for – if you get it wrong, it means your overpayment won't actually help you out that much. If you get this choice always, always tell your lender you want to reduce the term of your mortgage.
If your overpayment goes to reduce next month's payment, it just means that you're paying slightly early, so you save some interest, but not much. You'd still repay almost as much as you would sticking to contractual payments, and – crucially – you won't have reduced the term of your mortgage.
Be very clear that you want all future overpayments to reduce the term of your mortgage. Once you've agreed this, you can usually make overpayments through online banking by setting your mortgage account up as a new payee, then making payments as and when you wish.
If you want to overpay the same amount every month, you can set up a standing order to your mortgage account.
The answer to this, almost always, is that you should overpay – if you have the choice.
Decreasing the term sounds sensible, and does almost exactly the same job that overpaying does – both mean you pay more each month, you pay less interest, and your mortgage is paid off sooner.
However, if you've locked in to a contract with higher monthly payments, it means if you suddenly have a shock to your income, or if you're on a variable rate and interest rates rise, you might quickly start to struggle. If you're overpaying, you can stop the overpayments, which gives you more wiggle room if problems do arise.
Read my blog for the full pros & cons of overpaying your mortgage versus shortening the term.
Usually you can, yes. But think carefully, because you're already sort-of overpaying with your offset.
An offset mortgage keeps your mortgage debt and savings in separate pots with the same bank or building society. Though the big difference is your cash savings are used to reduce – or 'offset' – the amount of mortgage interest you're charged.
So, if you've a mortgage of £150,000 and savings of £15,000, then you only pay interest on the difference of £135,000.
The big difference between offsetting and overpaying is that for most mortgages – especially newer ones – if you overpay, that money is gone from you forever. You can't get your hands on it if you're suddenly short of cash. But, in an offset, the savings remain yours and can be withdrawn whenever you want with no problem (but obviously then it no longer offsets your mortgage debt).
So, think carefully before turning offsetting into overpaying...
Not usually, as most mortgages these days calculate interest daily, meaning that whatever day you overpay, your interest the next month is calculated on your new, lower balance – this is the ideal if you're an overpaying borrower.
But if you've had your mortgage for longer than 10 years, you might need to be on the ball to time your overpayment correctly, as it's possible your interest may be calculated monthly, quarterly or annually instead. If you're unsure, it's best to check your mortgage or call your lender to see which it is.
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...
Mortgage type Annually calculated Annually calculated Mortgage rate 5% interest 5% interest Calculation date 2 May 2 May Amount overpaid £10,000 £10,000 Overpayment date 3 May 1 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 ISA or easy-access savings account 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 about £500-£1,000.
The above all applies to interest-only mortgages too – if you make overpayments, lenders should apply these 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 on to a repayment mortgage an affordable option.
Now we hit 'interest'-ing territory (forgive the pun). Investing means putting money in a financial product that involves taking a risk in the hope the money will grow more quickly, although equally, you could lose.
While our calculator shows it's many won't find savings that beat overpaying a mortgage, the same isn't true with investing.
A top-performing investment will pay substantially more than 10% a year, yet one that performs badly can lose serious amounts of money too. This includes putting cash into your pension or buying more property (possibly as a buy-to-let) rather than paying off your home loan. If it goes well you'll gain, if it goes badly you'll lose. There are no guarantees.
We don't cover what to invest in as there's no right or wrong answer, only how to buy investments the cheapest way (see Share dealing need-to-knows and Stocks and Shares ISAs) so we won't be taking you much further along this road. If you need help on this, seek independent financial advice.
However, investing isn't wrong. Done well it's very profitable, provided you understand the risk you're taking.
But to generate the amount of investment returns equivalent to paying off your mortgage, you'd usually need relatively high-risk investments – overpaying the mortgage gives a surety of return.
Remortgaging? Overpaying could mean you save twice over...
If you're overpaying your mortgage, you don't just get the advantage of paying interest on a smaller amount of debt. Overpaying also means your loan to value ratio falls faster.
And if your LTV falls, it means when it comes to remortgaging, you may be able to get a cheaper deal than if you hadn't overpaid.
Therefore if you've got a sizeable savings pot, or you're overpaying month by month, by using savings to reduce your mortgage borrowing and cutting your LTV, you may get access to cheaper rates.
In truth, you'll need to be close to one of the key trigger LTV thresholds – where acceptability increases substantially and cost drops – for overpaying to make a difference. But if you are, the savings are huge. As a rough rule of thumb, the main thresholds are:
95% LTV: Above this, you won't be able to remortgage at all.
90%, 85%, 80%, 75% and 60% LTVs: Go below each of these and the top mortgage deals get cheaper.
Rates get cheaper as your LTV drops...
|Rates for £200,000 property, 25-year term, correct as of September 2022|
How to cut the cost of your mortgage
If you are close to an LTV band, or you're coming to the end of a mortgage deal, it's worth checking the market as mortgages have never been cheaper. Take a quick look at our Mortgage best buys tool to see what rates are available or find a broker to help you search in our Cheap mortgage finding guide.
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