Erin Gallacher, residential mortgage adviser looks at the benefits of overpaying your mortgage and the implications of doing so.
It may surprise you, but on a weekly basis I am almost guaranteed to get a call from a client asking whether or not they should overpay their mortgage. The answer, in my opinion is always YES (if funds allow of course!). As with all financial decisions, there are however a few things worth considering before you hand over the cash…
Can you comfortably afford to overpay?
It is always a good idea to have an emergency fund, so if overpaying leaves you without a cushion to fall back on, I wouldn’t advise it.
Do you have any other debt?
If you have any other debt outside of your mortgage at a higher rate of interest, then it may be worth looking at repaying this first. A qualified independent financial adviser (IFA) will be able to tell you which option will be most beneficial to you in the long run, so if you are unsure give one a call.
Does your lender impose any restrictions or penalties?
Early repayment charges (ERCs), also known as early redemption charges will be detailed within the terms of your mortgage and state what you will be charged if you repay your mortgage early. The charge usually ceases once the mortgage is out of its initial term, but it is worth checking first. However, most mortgage deals allow you some degree of flexibility throughout the mortgage, even during the ERC period. Normally you can overpay by up to 10% of the mortgage balance each year without being charged.
Now, onto the benefits of repaying your mortgage early…
- The quicker you pay off your mortgage, the less interest you pay. As a guide, if you had a mortgage of £150,000 which you repaid over 25 years on an interest rate of 1.29%, you would pay interest over 25 years of £77,910. If you paid the mortgage off over a shorter period of 20 years then you would pay interest of £59,293 (i.e. saving £18,617).
- Most lenders charge interest on a daily basis, so if you pay off a lump sum, your mortgage is adjusted straight away and interest will be charged on the reduced balance within 24 hours.
- Even making a small overpayment each month will make a huge amount of difference to you over the mortgage term.
Types of overpayment:
If you give the lender a lump sum and then opt to continue to make the same monthly payments as before, ultimately you will pay back your mortgage ahead of schedule, potentially saving you shed loads of interest.
If, however, cash flow is more important to you, once you have paid the lump sum, the lender can adjust your monthly payment down to reflect your new, lower balance. With this option, bear in mind you won’t pay off your mortgage sooner and you won’t save as much as making monthly overpayments.
No lump sum
If you have spare cash every month, you could simply choose to up your monthly mortgage payments. Some of my clients have chosen to do this because their mortgage rate is higher than the interest rate on their savings account, so in the long run they will be better off.
As with all these things, which option you choose, will depend on your individual circumstances and how much your lender will allow you to overpay.
Start overpaying now
To set up a regular overpayment and/or pay a lump sum, you’ll need to talk directly to your lender. If your income is irregular, it is usually possible to make ad hoc lump sum overpayments but again, give your lender a call to discuss.
Slightly off-piste but similar! An offset mortgage account is a bank account that is linked to your mortgage. It allows you to use your savings to reduce the amount of interest you pay on your outstanding mortgage balance. It’s a bit like overpaying and means you could pay off your mortgage more quickly with the added bonus of still be able to get access to your money.
On the flipside, you don’t earn interest on cash held in the account and rates are generally higher. Offset mortgages tend to work best for borrowers who have a large pot of savings that they can afford to leave untouched.
If you have any questions about overpaying or offset mortgages, please do get in touch. You can call me directly on 01625 416392 or call the main line on 0345 345 6788.
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17th April 2018