Most fixed rate mortgage products come with early repayment charges (ERCs). These vary between lenders and can be found detailed on your mortgage offer.
ERCs are penalty charges which apply if you pay back the loan in part or in full within the fixed rate ‘incentive’ period. This is with the exception of any allowable overpayments.
An example of ERC’s could be that within a five-year fixed period you’re charged 5% on your loan balance in the first year and this decreases through the set period to 1% of the loan balance in the last year.
Hearing this, most people will want to avoid any kind of penalty charge and make no changes to their mortgage payments for the fixed rate term to avoid any potential fees.
However most mortgage products have an overpayment allowance. This is typically 10% of the loan balance per year – although details vary from lender to lender.
I bring this to your attention though as it is a very interesting flexible feature that really CAN make a difference to you and your future. Also, when understood and used appropriately, can be worked to your advantage.
Here’s how – by making overpayments within the permitted allowance, you start to pay off more of the capital loan borrowed, meaning you’re paying off your mortgage quicker.
This naturally reduces the overall term of your mortgage, and reducing the term, reduces the amount of interest payable by you over time.
This, saves you money in the long term by reducing interest but it also enables you to own more equity in the property sooner.
Crunching the numbers: How much could you potentially save?
…If you paid the full 10% overpayment
For example, if your mortgage balance is £250,000, based on a 10% overpayment allowance per annum, you can pay up to £25,000 in overpayments that year without incurring any charges. That’s £2,083 per month extra, on top of your contracted monthly payments.
Now this, in reality, is an extreme example, not many people find themselves with that sort of spare money to make such an overpayment as a regular occurrence.
…If you paid £100 or £200 extra per month
However, the effects of making smaller but regular overpayments – let’s say an extra £100 or £200 per month, can still be significant.
You are effectively putting your money into savings – you are investing your money, via mortgage overpayments, in your home.
Here’s an example, please understand this example is for demonstration purposes only. To work out your own individual savings and term you can use an online overpayment calculator or reach out for professional advice.
Example: Mortgage loan of £235,000 over 25 years at 4.50% = £1,310pcm
If the above borrowers paid £1,410pcm (an extra £100) they would be mortgage-free in 22 years (three years earlier) and save £21,650 in interest by doing so.
If the above borrowers paid £1,510pcm (an extra £200) they would be mortgage free 5years and 4 months earlier than 25yrs and saved £37830 in interest by doing so.
Overpayments: ‘There’s flexibility in them’
I understand no-one wants to pay more each month, especially right now when the cost of living is high.
However, when you see the effects of these overpayments you can start to understand why you might find this a positive financial step.
If you do find you have some extra money within your budget to put towards this each month, you may even start to feel excited at the countdown to mortgage freedom.
Seeing that the money paid each month is working for you and essentially being saved within your property.
Many people understand property to be an investment. History suggests property value tends to increase over time. Of course, it does fluctuate in the short term, but in general they tend to increase over the years.
So, paying down your loan increases the share of equity you own and with values potentially increasing over the years this return on investment looks even more favourable.
I hope this inspires you to at least look at your overpayment options and discuss if reducing your term in this way is important to you. What’s great is these overpayments are an optional choice you have and not contractual, so there’s flexibility in them.
It can feel empowering, whether you decide to overpay or not, just to understand your options fully and recognise the impact these decisions can for your future.
Gemma Bennett is a senior mortgage broker for The Mortgage Mum
If you’d like to find out more about traditional saving, including tips on how to start putting money away for a deposit, Gemma’s colleague Sonya Matharu has covered this topic in Part 1 of this feature. Read it here.
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Connect with The Mortgage Mum team
You can connect with Sonya via her website www.sonyamatharu.com and you can contact Gemma via email Gemma@themortgagemum.co.uk: or at her website, here.
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