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Should I overpay my mortgage?

Should I overpay my mortgage?

Can you use savings to overpay?

Martin Lewis and Helen Saxon | Edited by Johanna Noble

Updated 1 January 2018

With savings rates at rock-bottom, overpaying on your mortgage is often a no-brainer. And for many it is, with gains of £10,000s in interest possible.

But there are negatives – including repayment penalties, losing an emergency fund and more. This guide helps you decide if it's right for you.

In this guide:

Overpaying often wins, but not for all

Overpaying vs saving – which wins?
- Personal savings allowance may change this
Remortgaging? You could save twice over
How much will I save by overpaying?
Mortgage overpayment Q&A

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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 beats the returns possible by putting it in savings, given savings rates are currently so pitiful.

Overpaying means you make the same gain as saving at your mortgage rate. If you've a 3% 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'd need to earn 5% – impossible to get on standard savings now.

Here are some real-life examples:

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.
– Debbie

From 2005, threw an extra £600 per month at mortgage, paid off 4yrs early. Thanks
– Steve

But before you chuck all your savings at your mortgage, know the following...

Most can overpay 10% per year, but check. 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, tracker or discount period.

If 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.

Some may levy a flat rate of 5% regardless of when you may make any overpayment while others - particularly fixes for 5 yrs or longer - will often charge the same percentage on your overpayment that equates to the number of years left on your loan.

Say you’ve a 5-yr fix on a £100,000 mortgage and decide to overpay a lump sum two years into the deal. However, instead of sticking to the 10pc (£10,000) limit free of penalty, you overpay £15,000 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.

If you've other, expensive debts, clear 'em first

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.

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

You have outstanding student loans

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 this, it's the one core type of loan you should overpay your mortgage ahead of.

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?
You are a 0% credit card tart

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 (eg, stoozers). 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%
You may not be allowed to overpay a personal loan (taken out pre-2011)

Many loans are structured repayments, which means you have a designated amount to repay each month, over a fixed term. While you are allowed to clear the debts in full (though there can be small repayment penalties for doing so), many older loans do not allow you to make monthly overpayments that don't actually wipe them out.

A change in rules came into place on 1 February 2011 which means you're able to make partial overpayments on loans taken out after this date. Banks may charge you for this, however they're only allowed to in certain circumstances, and the maximum charge is 1% of the amount repaid (if the loan is for over a year) or 0.5% (if under a year).

For anyone with loans from before Feb 2011, even though such a loan's likely to be more expensive than your mortgage, if you don't have enough funds to clear the debt IN FULL you may want to use any savings toward your mortgage instead.

However if you are close to having enough to clear the loan, and will be able to get the whole amount together soon, it's likely to be worth waiting.

Ensure you have sufficient emergency funds

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 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 – 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.

The exception – mortgages with flexible features

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 new 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.

See the Ultimate Mortgage Calculator to do a comparison, plus see the Mortgage and Remortgage guides.

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Overpaying vs saving – which wins?

If you've got this far, we're going to assume you're debt free, you have an emergency fund, 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 2.99%,
Annual interest cost is: £299

If you have £10,000 savings at 1%,
Annual interest earned is: £100

Pay off the debt with the savings and you are £199 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.

You are allowed to earn up to £1,000 of interest tax-free

Since 6 April 2016, the new personal savings allowance means every basic-rate taxpayer can earn £1,000 interest without paying tax on it; equivalent to the interest on £75,000 in the top easy access savings account - so 95% of people won't pay any savings tax at all.

Higher-rate taxpayers get a £500 personal savings allowance, but additional taxpayers don't get any.

This doesn't just apply to savings accounts, it's for any interest from bank accounts, credit unions, building societies or even peer-to-peer lending. And it'll be automatic, you'll be paid interest gross (ie, with no tax taken off). For full info and what to do if you'll earn over the limit see our how the personal savings allowance works guide.

This can have an interesting effect because some may have savings where interest exceeeds the personal savings allowance.

Martin Lewis says...

For those with a decent whack of savings, whether to overpay your mortgage can get a little complicated. So I want to explain with an example scenario.

Here’s the set up – I’ve deliberately chosen easy numbers….

You’re a basic-rate taxpayer so you have a £1,000 tax-free personal savings allowance
Your mortgage rate is 2.8%
You have £40,000 of savings
Your savings are all at 3% interest

Therefore the total interest you’d earn in a year before tax is £1,200 of which £1,000 is tax-free, while the remaining £200 is taxed at the basic 20% rate.

To work out whether you should overpay you need to see if your mortgage rate is higher than the after-tax rate on your savings.

Yet the personal savings allowance means even though all your savings are in one account, they’re actually at two different rates after-tax.

The tax-free rate on your first £1,000 of interest (which is generated from £33,333 of savings), is 3%.
The after tax rate on the remaining £200 of interest (the final £6,667 of your savings) is at 2.4% (as 20% off 3% is 2.4%).

Therefore the tax-free interest earns you more than the mortgage costs. Yet the taxed interest doesn’t so you you’d be best off to put £6,667 but no more towards your mortgage.

As you can see it is really worth taking this slowly and doing your sums.

So for some people you may find it worthwhile to overpay some of your mortgage, but not all. Main thing is to make sure it's worthwhile for you.

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.

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 often available. 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. Take our test

We'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...

Tool: Should I overpay my mortgage with savings?

The new personal savings allowance (PSA) means every basic-rate taxpayer can earn £1,000 interest without paying tax on it (higher rate £500). This is reflected in the calculator below.

Once the calculator tells you what savings rate you need, check out the Top Savings Accounts or Top Cash ISA guides to see what's currently available. For the vast majority of people, making extra mortgage repayments wins.

The size of the savings possible

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 will usually beat savings...

How much will overpaying your mortgage save you?

SAVING/OVERPAYMENT PER MONTH	MORTGAGE TERM REDUCTION	TOTAL MORTGAGE INTEREST SAVED OVERPAYING A £150K MORTGAGE AT 2.99% (1)	INTEREST IF YOU SAVED THE OVERPAYMENT AT 2% (2)
£10	Six months	£1,420	£860
£50	Two years, four months	£6,520	£3,500
£100	Four years, three months	£11,790	£5,800
£200	Seven years, three months	£19,800	£8,375
£500	12 years, seven months	£33,530	£9,960
£1,000	16 years, eight months	£43,680	£8,800
(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 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.

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...

TABLE_CELL_STYLE	2 YEAR FIX EXAMPLES	5 YEAR FIX EXAMPLES
95%	3.29%	3.49%
90%	2.01%	2.45%
75%	1.85%	2.15%
60%	1.79%	2.05%
Rates for £200,000 property, fee-free, 25-year term, correct as of Sep 2018

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.

Calculate how much you'll save 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.

Mortgage overpaying: Q&A

If it all adds up that overpaying is the right option for you, here's how to do it, and other things to consider before taking the plunge...

How do I overpay my mortgage?

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 (and all those in future too) is 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.
Should I overpay my mortgage each month or ask my lender to officially reduce the term?

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 Martin's blog for the full pros & cons of overpaying your mortgage versus shortening the term.
I have an offset mortgage. Can I still overpay?

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...

Does it matter when I overpay?

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...

	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 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 around £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 onto a repayment mortgage an affordable option.

Is it worth investing rather than saving?

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 for many it's very tough to 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.
Isn't paying off a mortgage investing in the property market anyway?

No. Buying a home in the first place is investing in the property market. Repaying your mortgage more quickly is paying off an outstanding debt. While the two acts are part of the same thing, by repaying your mortgage more quickly you're not altering the state of your investment – your house is neither more nor less likely to rise or fall in value.

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