What are mortgage overpayments?

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At first glance, paying more on your mortgage seems like a no-brainer. Why would home loan customers not want to clarify as soon as possible what could be their biggest home loan?

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Dig a little deeper, however, and things may be a little less straightforward than they used to be. Here’s what you need to know about paying more on your mortgage.

What type of mortgage?

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By ‘mortgage’, in this context, we are referring to the repayment mortgage, which is the most common form of home loan in the UK. This is where customers pay both capital and interest to the lender every month.

When you take out a repayment mortgage, your lender determines what your payments will be each month to pay off the loan at the end of an agreed term, such as 25 or 30 years.

What is a Mortgage Overpayment?

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If you pay more than this contractual amount, you are effectively overpaying your mortgage.

Even if the overpayments each month are only a small amount, they will reduce the total amount of interest to be paid over the life of that mortgage and, in turn, shorten the term.

However, you can’t pay more than what you like when you want. This will depend on what kind of mortgage deal you have.

For example, if it’s a lifetime tracker mortgage, on which the interest rate you pay can fluctuate, you may be allowed to pay unlimited more. The same goes for flexible offset mortgages or the lender’s standard variable rate mortgage (SVR) deal.

But if you are on a deal with tie-ins during which early redemption fees (ERCs) are payable, if you break the contract early, penalties will apply if you pay more than the prescribed limit. Examples are fixed or tracker deals of, say, two or five years.

In this case, most lenders allow penalty-free overpayments of up to a maximum of 10% in one year of the outstanding mortgage balance. But always check the terms with your lender before conducting an overpayment.

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The 5-star TrustPilot rated online mortgage advisor, Trusley, helps you find the right mortgage – and works with the lender to secure it.*

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Should you pay more?

There are many benefits to overpaying but it may not always be the best idea.

For example, if you have other debts in addition to your mortgage, the most sensible course of action is usually to deal with the ones with the highest interest rates. In this instance, credit cards and personal loans may come in above the pecking order compared to mortgages.

Even if you hold off on a mortgage when you’re free of other debt, it’s worth reviewing whether you have enough spare cash for an emergency before thinking about overpaying.

A useful rule of thumb is to have a ‘rainy day’ corpus of between three and six months of your pay before you focus on mortgage overpayments.

How do overpayments work?

Considering the above and assuming that it makes sense to overpay your home loan, there are two ways in which you can pay more.

The first is to use an ad hoc or sometimes a lump sum amount to pay off your home loan. For example, an annual bonus or other cash windfall that has come your way. Another option is to pay more on a regular monthly basis.

In any case you should contact your lender to arrange an overpayment.

If you decide to make regular overpayments, you can tell your lender how you want to use them against your loan. They can, for example:

  • Reduce subsequent mortgage payments and keep the term the same
  • Reduce loan tenure and keep monthly payments the same

In most cases it makes sense to use higher payments to reduce the mortgage term. The result should be that you pay off your mortgage loan much earlier than the principal time.

How much money can you save?

The following example shows why it’s worth considering making a mortgage overpayment.

Let’s say you had a repayment mortgage of £200,000, where the interest rate was 3%, with 20 years left to run. The normal monthly payment would be £1,109.

On the assumption that you can increase your monthly repayment from £100 to £1,209, you will be able to reduce your mortgage term by over two years to 17 years and 10 months. You will reduce the total amount of interest you pay by approximately £8,000.

lump sum overpayment

Now let’s assume the same mortgage scenario, but instead you pay a lump sum of £20,000 more, keeping your monthly payments the same.

In this example, you would reduce the mortgage term to two years and seven months and reduce the total amount of interest you would pay from £66,206 to £51,165. Savings of over £15,000.

Combine the above two options and you will not only reduce your mortgage term by about four and a half years, but you will also save over £20,000 in interest.

additional benefits

As well as paying off the mortgage more quickly and saving a significant amount in interest payments, another benefit from paying more is that you increase the amount of equity in your property more quickly.

In turn, this lowers your loan-to-ratio (LTV) profile. LTV is used by lenders to determine how much risk they are taking when weighing mortgage applications. Lowering your LTV qualifies you for cheaper mortgage options if you choose to re-mortgage at some stage.

How to start/stop overpayment

Contact your lender to discuss more payment options and how these can be made. And importantly, are these allowed to be penal-free as well as any other restrictions.

One-time overpayments can usually be made by bank transfer. If you use Internet banking, some lenders will allow you to change your online mortgage payment accordingly. You may be able to set up your mortgage account as a payee so you can make more payments whenever you want.

Can you pay less?

When you overpay your home loan, you may need the flexibility to borrow your money back or have the option to pay less in the future.

If your mortgage is fully flexible, or if it is an offset deal, you should be able to borrow back the amount you overpaid and also pay less within certain limits.

Another factor is less likely to be taken into account before going the other type of mortgage and the overpayment route.

free mortgage advice

The 5-star TrustPilot rated online mortgage advisor, Trusley, helps you find the right mortgage – and works with the lender to secure it.*

Compare Mortgages

*If you do not continue to repay your mortgage, your house may be repossessed.

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