If you are in the fortunate position of having some spare cash – either on a regular monthly basis or as a lump sum – then it might be a good idea to consider using it to overpay your mortgage. Paying more to your mortgage than the contractual monthly payment – even by a little – will reduce the balance you owe, which in turn reduces the amount of interest you are charged over the remainder of the mortgage term. Working out whether it is a good idea can be as easy as comparing the interest rate you would receive on a savings account with the interest rate you are charged on your mortgage debt.
Say you have £5,000 in your savings account, earning interest at 2 per cent; that means you gain £100 per year. If your mortgage interest rate is 3 per cent, then by paying that £5,000 off your mortgage instead, you save £150 in interest over a year – a £50 gain in comparison to the interest on the savings account. You can apply a similar calculation to regular payments – for example paying an extra £100 per month to your mortgage versus putting the same amount into a savings account. That’s a simple example, but it illustrates the basic principle. And as well as reducing the amount of interest you are charged, you will also pay off your mortgage faster.
There are, of course, other factors to take into account when you decide whether to overpay your mortgage. The first consideration has to be any other debt you have. If you have loans or credit card debt, for example, you should aim to pay those off first, as the rate of interest will typically be much higher than your mortgage. Paying your unsecured debt down will usually benefit you more financially, in both the short and the long term.
Do you have you an emergency fund? As a basic rule of thumb, if you can keep the equivalent of three months’ salary in the bank, then that will provide a buffer should something unexpected happen. In this instance you are often better accepting a lower interest rate on savings in the bank than you could save on mortgage interest payments; if an emergency coupled with a lack of immediately available funds meant you suddenly had to borrow, it would likely cost you more.
Some mortgages have flexible terms that mean you can overpay (reducing your interest charges) but then borrow back the amount you have overpaid should you need it. This is arguably the best of both worlds – you benefit financially from your overpayment, but still have access to the money should you suddenly need it.
Finally, remember that the lender has calculated the interest they will gain over the term of the mortgage with the intention of making a profit, and if you overpay you potentially eat into their share of the deal. To counteract this, some mortgages impose early repayment charges, while others may only allow you to overpay up to a certain percentage of the total mortgage balance per year without charging a fee. If in doubt, check your original mortgage paperwork or your annual statement to ensure there are no penalty clauses for overpayments or part repayments.
Author: Steven Miscandlon
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