We have all had the dream – the one where we imagine what we would do if we won a big cash prize. Along with going on the holiday of a lifetime and giving cash gifts to family and friends, paying off a big chunk of the mortgage and unburdening ourselves of debt is pretty alluring.
But even if you were the beneficiary of a smaller windfall such as a bonus at work or a tax rebate many of us would probably prioritise our home, and pay a bit extra on the mortgage, if we had no other pressing debts or outlays which needed attention.
According to a survey by Leeds Building Society a quarter of people who took out mortgage deals which offered cashback ploughed the money straight back into their home by overpaying their new mortgage.
This was more than the proportion who decided to make improvements or undertake repairs to their new home. It highlights just how keen we all are to get that big debt paid down as fast as possible.
Experts agree making an overpayment wherever you can – even if it’s just a small amount – will have major benefits, not least reducing the term of your mortgage and, consequently, slashing the interest payments over time.
But, if you are considering making overpayments on your mortgage, there are a few matters to contemplate first.
Here we guide you through the pros, cons and offer some tips on how to make sure you are making the correct repayments.
What, exactly, is overpaying and who should do it?
There are different ways people ‘overpay’ on their mortgage.
There are those homeowners who, for example, receive a big inheritance, win a prize or cash in an investment enabling them to pay off their mortgage in full or drastically reduce the debt.
The other, more common, way to overpay is by repaying a higher amount either annually or at regular intervals. This is typically employees who earn annual bonuses or commission or who do lots of overtime.
Indeed, some self-employed workers with fluctuating earnings might also want to make overpayments some months to make up for a shortfall on others.
And then there are those people who want to top up their repayments with an extra £50 or £100 a month to reduce the term.
According to the Yorkshire Building Society, a fifth of borrowers are in credit on their mortgage because they have made overpayments. It’s a popular way to repay.
The pros
There are many advantages of overpaying. Yorkshire said for some customers overpayments were a way to pay off their mortgage sooner than they had originally planned, potentially reducing the amount of interest they paid over the term of the mortgage.
For others, regularly repaying more than the fixed monthly amount helped to pre-empt an expensive period in the future that could allow a payment holiday – an agreed temporary break in repayment. This could be acceptable if the mortgage account was in sufficient credit.
Interest rates on mortgages are currently very low and some are predicting they will plunge even lower, making overpaying now a potentially smart move for those who can afford it.
Greg Cunningham of mortgage intermediary Alexander Hall, said: “In this current low mortgage rate environment it is sensible for clients to overpay where possible, for example if they have received a lump sum or earn irregular income, and of course means paying less interest over the lifetime of the mortgage if you do so.”
The cons
Overpaying on your mortgage is not for everyone. And suitable candidates should still be aware of the pitfalls.
Charles Mungroo, senior mortgage manager at Yorkshire Building Society, said: “While it’s great to see so many borrowers value the option of managing their mortgage flexibly, it’s really important people understand the facts and implications of making overpayments to decide if it’s right for their circumstances.
“For example, while it could help reduce the amount of interest you pay, you can’t retrieve an overpayment if you need the money back. Likewise, it may mean you can pay off your mortgage quicker but if done wrong, could mean you incur fees. There’s a lot for borrowers to weigh up.”
In fact, most mortgage lenders allow overpayments of up to 10% per year, a feature built into most mortgages. If you have a mortgage for £200,000, you would be able to pay £20,000 each year without extra charge.
However, pay more than this amount and you will incur penalties which may erode the value of making the overpayments.
These will come in the shape of something called early repayment charges (ERCs) which will be triggered if you unwittingly pay more than the 10% (or whatever the overpayment ceiling is on your mortgage).
It’s important, therefore, you check the terms and conditions of your mortgage to make sure you know the exact level of overpayments allowed without penalty and the cost of the charge itself.
Mungroo added: “If your mortgage terms allow overpayments and you can afford to make any additional contributions, no matter how small, over time you could really start to see some benefit.
“However, taking on a mortgage is likely to be one of the biggest financial commitments you will make in your life so it’s essential you understand all the facts before making use of flexible features on your mortgage to help you manage your finances in the future.”
Products with no early repayment charges
There are some mortgages which allow more flexibility. However, you will probably end up paying a slightly higher interest rate for the benefit of this facility.
According to Cunnington, an increasing number of products have come to the market with no early repayment penalties.
He highlighted HSBC, Santander, Nationwide and Barclays as lenders offering products with this feature along with ‘very attractive’ tracker rates.
He said some lenders, such as Metro, also allowed 20% overpayments when fixed in instead of 10%. Meanwhile, Coventry Building Society often have competitive fixed rates with no penalties.
“This increased innovation from lenders in this space has opened up some very attractive options to clients who do want the flexibility to overpay higher amounts than the normal 10%,” Cunnington added.
How do I make an overpayment?
If you are already a homeowner with a mortgage, speak to your provider to find out how to add the extra money onto the repayments.
If you are about take out a mortgage either as a first-time buyer, a home mover or if you are remortgaging your current deal and you think you would like to make overpayments, speak to your broker or lender about the options open to you before taking out your mortgage.
Cunnington said it’s important to be certain you need the flexibility to over pay by more than the standard before looking for a more flexible product in order to avoid the additional costs.
Alternatives
For clients who like to budget, Cunnington said it may be preferable to actually look to lower the mortgage term to an amount within your comfortable monthly budget rather than have to have the commitment and discipline to overpay.
“Every client scenario is completely different in this respect and this is where it is key for clients to receive advice from an intermediary who will discuss all of these options,” he added.
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Overpaying – is it for you?
Yorkshire Building Society explains what to do before making the decision to overpay:
Do your research
Always check your existing mortgage deal to understand the terms of your mortgage and find out any potential fees that may be applied in the event you pay off your mortgage early.
Speak to your lender
If you think overpayments could work for you, speak to your mortgage provider to find out if this is something you could make use of, and on what terms.
Clear any debt
Usually, the interest charged on unsecured debt, such as loans and credit cards, is more than for a mortgage. So try to pay existing debts before you begin to overpay on your mortgage.
Are your savings paying?
If the interest rate you earn on your savings is higher than the interest rate charged on your mortgage you might be better leaving it where it is, than overpaying on your mortgage.
Don’t leave yourself short
Before committing your spare cash or savings to overpayments, check you have enough in reserve to support you in an emergency – for example, if boiler or car broke down. Once it’s used as an overpayment, you can’t get the cash back.
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