Homeowners facing hefty rises in their mortgage repayments may be considering using any spare cash to overpay their mortgage and chip away at their balance.
A series of interest rate hikes means that the average rate for a five-year fixed rate mortgage has reached more than 6%, according to Moneyfactscompare.co.uk. But rising interest rates also mean that savers are benefiting from some of the highest rates in decades, with some fixed rate accounts paying more than 6%. Whether overpaying is the right option for you will depend on your current mortgage rate, and your personal financial situation.
Here, we explain what you should consider before using spare savings to overpay your mortgage.
Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage. If you’re looking for expert mortgage advice, you can speak to an independent mortgage broker with Unbiased. Every advisor you find through Unbiased will be FCA-regulated, qualified and unconnected to product providers – so they can offer you truly unbiased advice.
The impact of mortgage overpayments
The main benefit of overpaying your mortgage is to reduce the amount you owe, the interest you’ll pay during your mortgage term, and clear your debt faster. The majority of lenders allow you to overpay by up to 10% of your mortgage balance each year, without penalty. You can overpay with a lump sum from an inheritance or bonus, for example, or make smaller monthly overpayments with any surplus income.
For example, let’s say you have £150,000 left on your 15-year mortgage on a fixed rate at 6%. If you use a £10,000 lump sum (10% of the mortgage balance) to overpay your mortgage, you’ll be mortgage-free one year and six months earlier than you would have been otherwise. You’ll also save a hefty £13,380 in interest payments over the term of your mortgage.
However, making smaller monthly overpayments can be more beneficial. For example, by overpaying £200 a month, you’d knock over three years off the mortgage term, and save yourself over £17,200 in interest.
If you’re thinking of overpaying your mortgage, read our article Paying off your mortgage early – how to get the best results.
When overpaying may be the right option for you
Overpaying your mortgage is generally considered a good strategy if the rate you’re paying on your mortgage is greater than the rate you’re earning on your cash savings. So whether or not it’s the right option for you will depend on your current mortgage rate, and the rate you’re earning on your savings.
On a savings balance of £10,000, you’d earn £435 in interest over a year before tax, assuming your savings were in a top easy access account paying interest at 4.35%. This compares to savings of £560 for the year if you used this money to overpay a £150,000 mortgage on a rate of 6%. In this scenario, it may make sense to use some of your savings to reduce your mortgage balance. Remember, however, that once you’ve used your savings to overpay, you cannot get them back, so it’s essential that you keep a cash buffer in place in case of any unexpected expenses.
Reducing your mortgage balance by overpaying could also enable you to access better deals when the time comes to remortgage. That’s because you may cut your loan-to-value (LTV), which is the amount you borrow in relation to the value of the property. The best rates are typically reserved for borrowers with an LTV at 60% or lower. For example, if you want to borrow £180,000 against a property valued at £300,000, this amounts to an LTV of 50%. Read more in our article Should I overpay my mortgage?
When overpaying your mortgage may not be right for you
If you’re still on a mortgage deal that you took out a couple of years ago, your rate is likely to still be low. Instead of using spare cash to overpay your mortgage, you can benefit from rates of more than 6% on 12-month fixed rate savings accounts, so rather than overpaying, you may want to think about saving your money and then using it and the interest you’ve earned on to reduce your mortgage balance nearer the time you need to remortgage . Read more in our article Fixed rate savings bonds explained.
Beware early repayment chargesIt’s usually not a good idea to overpay on your mortgage if you’ll pay a hefty Early Repayment Charge (ERC), which can amount to between 1% to 5% of your outstanding mortgage balance. This could be a significant sum which outweighs any benefits to overpaying. Read more in our guide Mortgage fees and costs explained.
If you have a £150,000 mortgage, even a 1% ERC will amount to £1,500. You have to do the sums to work out whether overpaying is worth it if you’re hit by an extra fee, though in some cases it still may be worth paying this for the total savings. Make sure you check your particular mortgage deal’s terms and conditions before making an overpayment.
Remember, too, that as mentioned you should ideally keep a pot of spare cash set aside for emergencies, such as roof repairs, or to cover your bills if you’re out of work for a while. As the past few years have shown, you may need access to this money as nobody can be sure what’s around the corner. Generally, it’s considered wise to have at least three to six months’ worth of income (after tax) set aside. Read more in our article How to build an emergency fund.
You can’t get any overpayments you make back once you’ve made them, so you should only commit to paying in extra if you are sure you won’t need this money in the future. Read more in our article Should I overpay my mortgage?
Alternative options to manage rising mortgage payments
If you can’t afford to make overpayments to reduce your mortgage balance, there is some good news, as the government has announced that borrowers are able to make a temporary change to their mortgage terms, such as extending the term (or switching to interest-only).
These are some of the alternative options that may help borrowers to manage the impact of interest rate rises for a short time. Using these strategies will not affect your credit score, as it may have done previously. Find out more in our article Government announces support for mortgage holders.
For example, if you extended your £150,000 mortgage on a rate of 6% from 10 to 15 years, your monthly payments would drop by £404 a month from £1,655 to £1,266. Remember, though, that this will increase the amount you pay back overall.
If you decide to move from a repayment to an interest-only mortgage for a while, this will reduce your monthly payments because you are not paying off any of the capital, only the interest on the loan. However, you will need to consider how to repay the capital in the long term.
Another option if you’re in your 50s or 60s may be to consider a retirement interest-only mortgage, which enables you to carry on making interest payments indefinitely, with the loan paid back only when you die or move out. By contrast, a standard interest-only mortgage finishes on a specific date and you must repay the capital you owe at this point. Read more in our article How retirement interest-only mortgages work.
Find out more in our article Five strategies to manage rising mortgage payments.
Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage. If you’re looking for expert mortgage advice, you can speak to an independent mortgage broker with Unbiased. Every advisor you find through Unbiased will be FCA-regulated, qualified and unconnected to product providers – so they can offer you truly unbiased advice.
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