Should you be Overpaying your Mortgage?
With savings rates ever fluctuating, overpaying on your mortgage can sometimes be an attractive proposition for homeowners. But is it always the right choice? Let’s find out.
Overpaying a mortgage is when you make a payment above your normal monthly payment. This can be in the form of one lump sum or may be small amounts each month. Overpaying a mortgage might seem a great idea for many. It can make life easier, save you large sums of cash in the long term and help you make a dent in the ‘expensive debt’ you’ve amassed since buying a home. For those wondering how this is possible, the more you reduce your mortgage means the less you’ll be paying in interest. As a result, this can leave thousands of buyers every year looking for a mortgage which doesn’t charge a penalty on the amount that you overpay. In turn, this money that you save in mortgage interest often provides a better return for you than putting your money into a standard savings account.
Ultimately, it’s also important for you whatever amount you are overpaying is effectively earning an interest rate equivalent to your mortgage interest rate. This is likely to be much more lucrative than a personal savings account. If your current mortgage rate is 3% & you make an overpayment of £10,000 then that overpayment is saving you circa £300 each year for the remaining term of your mortgage. Left in a savings account, that £10,000 would be doing well to earn you £50 in interest.
What are the formalities when overpaying a mortgage?
If you’re looking to make an overpayment on your mortgage, make sure you’re aware of any potential penalties. While most lenders allow you to pay up to 10% of your outstanding mortgage amount per year without penalty, this isn’t always the case.
A few lenders chose to charge those who try to overpay on their mortgage. Why? This is because if you overpay by too much then lenders can lose a lot of money through interest they are unable to collect as you no longer owe the money. This penalty can range from around 1% - 5% of the overpaid amount so make sure you check with your lender how much you can overpay if it’s possible at all!
Is overpaying your mortgage a luxury?
While we’ve shown you how overpaying a mortgage can be great for you, it shouldn’t necessarily always be your priority. If you have other debts we strongly advise that you try and clear these first. Now, you might be wondering why we’re recommending this after showing you how overpaying your remortgage can save you money… The reason is that if you have debts outstanding on high-interest credit cards and loans, it’ll be important to clear these as they’re generally more expensive. Believe it or not, your mortgage is likely to be the cheapest borrowing you have. Why start overpaying a mortgage to save 3% interest when you still have several thousand on a credit card where the charges may be 25%.
While this is a rule that you should generally follow, there are of course exceptions. For example, if you have any outstanding student loans or you have a 0% credit card. For the former, paying off your loan depends largely on whether you can pay it off within a 30-year period and you must also be earning of excess of £25,000 per year. Therefore, if you feel like paying off your student loan might drain you of any needed cash at the moment then, it may not be worth doing it until you hit the aforementioned criteria.
With regards to a 0% credit card, we recommend this only for those of you that have good credit scores. If you’re smart, you can be someone who transfers money between credit cards so that you can take advantage of lower interest rates. But, make sure you have the discipline to keep on top of your finances and manage them effectively. Also, remember that the card may have a 0% balance transfer but may come with some sort of administration charge, which needs to be factored in.
Ensure you have emergency funds:
So, you’ve hatched the perfect strategy for overpaying your mortgage, it’s been checked with your lender, now what? Having a back up plan is never a bad idea. This can come in the form of an emergency fund - we recommend a minimum sum equivalent to three months salary. It's great paying that lumps sum off of your mortgage as you're likely to save more in interest than the money is making in a savings account but, what’ll happen when you need to pay for any emergencies? If you’ve used up a large chunk of your money on overpaying your mortgage then you may be made to borrow to cover something unforeseen, which can in turn create a whole minefield of problems for you.
If you’ve got any more questions, contact one of our team at Mortgages Online. Seeing as we can make your life easier, contact us! We’re free to use – so why not?
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