Is overpaying my mortgage a good idea?

Overpayment of mortgage is not for all

The benefits of overpaying a mortgage are clear: you pay off the debt you have accrued from buying the house, meaning you will pay it off quicker; you won’t pay interest on the amount you overpay; and the funds you save on interest are usually higher than possible returns if placed in savings (since savings rates are currently low).

But overpayment on a mortgage is not for everyone. Before throwing your savings into your mortgage, you should be sure of the following:

Overpayment with/out penalty. If you are still in your introductory discount or fixed period, many lenders will let you pay 10% of your mortgage balance as an overpayment each year. For a tracker mortgage—or if you are past the introductory period and paying your lender’s standard variable rate (SVR)—you can typically overpay as much or as little as you like.

Some lenders, however, will punish you for attempting to overpay by adding fees, which usually run between 1-5% of the amount overpaid, depending on your mortgage. Remember: lenders budget to earn a certain amount of interest during the mortgage deal—overpaying means they will receive less.

Pay other expensive debts first. Clearing your most expensive debts first is a good general rule. Doing so ensures interest does not build up so fast, saving you money and providing you an opportunity to clear debts sooner. Since they are typically more expensive, it is better for you to pay loans and high-interest credit cards before overpaying your mortgage.

You need a sufficient emergency fund. Early overpayments might not stop lenders from charging you if you run into trouble making monthly repayments. But beyond that, there may be other reasons you need a robust emergency fund—such as home repairs or losing your job.

Usually, ensuring you have three to six months worth of money is a good idea. If you have to choose between an emergency fund and mortgage overpayment, choose the emergency fund. The exception is mortgages with flexible features that will allow you to overpay and then borrow the money back, if need be.

Is it better to overpay mortgage or reduce term?

Given the option, you should almost always overpay your mortgage rather than reduce the term. It’s true that the differences between overpaying your mortgage and reducing your term seem almost negligible: either means you pay more each month, pay less interest, and pay your mortgage off sooner. 

If, however, you are locked into a contract that requires higher monthly payments, you could quickly start to struggle if you have a sudden shock to your income or if you are on a variable rate and the interest rises. If you are overpaying instead of reducing your term, you can get more wiggle room if a problem should arise by stopping the overpayments.

How to make a mortgage overpayment

When you first make a mortgage overpayment, it is typically easiest to phone your lender to talk about any overpayments that you are planning. Doing so will let you check on any fees or limits. You can then make your payment by bank transfer or debit card.

Opening that line of communication will also enable you to ask your lender about the best way to continue making overpayments: in a branch, by phone each time, or by standing order, for instance.

Bank transfer is typically the best way to make a lump sum overpayment. Some lenders will allow you to change your mortgage payments online if you have online banking. To make overpayments if and when you like, you may also be able to set up a mortgage account as a payee on your online banking.

When making an overpayment, your lender might offer you the option of reducing next month’s payment by the amount you have overpaid or to keep the payments the same and reduce your mortgage term instead. If given this choice, always tell your lender that you want to reduce the term of your mortgage. Otherwise, it just means you will pay off your mortgage slightly earlier, saving you some interest, true—but not much.

The benefits of mortgage overpayment

The benefits of mortgage overpayment are that you can pay off your mortgage more quickly and pay less interest generally. Mortgage overpayment also increases the equity you own in your property, meaning you will have a smaller loan-to-value (LTV) ratio, which, if you ever want to remortgage, makes you eligible for cheaper mortgage products in the future.

 Oftentimes, it makes more financial sense to overpay since, with interest rates being as low as they are, most people will pay more interest on their mortgage than they earn on their savings.

Things to watch out for when overpaying mortgage

A few things to watch out for when overpaying your mortgage include:

Mortgage lenders may charge a penalty if you pay more than your standard monthly amount. For instance, it may make more sense financially to put your extra money into a savings account if the penalties of overpaying outweigh what you will save—so it is important to check before you start making overpayments.

As mentioned, it is a much better idea to pay off other more expensive debts before considering overpaying your mortgage.

Make sure your overpayments are going toward paying off your overall balance and not just the interest.

Unless you have a flexible mortgage—which could allow you to make overpayments and borrow money back if need be—keep a chunk of your savings to cover unexpected emergency expenses.