With mortgage repayments representing most homeowners' biggest financial commitment, many dream of being able to become mortgage free. Add to that the potential to save thousands of pounds in interest payments if you do manage to pay off the debt sooner and it is easy to see why people are looking for ways to turn this dream into a reality.
In this article, we explore whether you should overpay or remortgage* to restructure your mortgage and the factors you should consider when working out whether it is better to save money instead.
How does overpaying your mortgage work?
Overpayments are payments that you make to pay your mortgage faster and they can be made in the form of one-off payments or regular payments. Mortgage overpayments are made in excess of your normal monthly mortgage payments and they can help to reduce your mortgage term, meaning you pay less interest overall. Mortgage overpayments can instead be used to help reduce your future mortgage repayments, rather than reducing your mortgage term.
Most lenders allow you to overpay your mortgage but there are rules and limits to how much you can overpay each year. If your overpayments breach these rules, you could incur a financial penalty, reducing the benefit of overpaying. We explain what to look out for later in this article.
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How to make overpayments on your mortgage
In order to pay off your mortgage sooner, you need to take control of the overall debt and reduce the term of the mortgage. This means redirecting a proportion of your finances to overpaying your mortgage and/or cutting down on the length of the mortgage term. There are also mortgage products specifically designed to help you pay off the debt quickly and more efficiently.
The main ways to overpay your mortgage are:
Make one-off lump sum overpayments
By diverting bonuses, inheritance or savings into your mortgage, you can begin to significantly reduce your outstanding mortgage debt. As we will discuss later in the article, you need to check if there is a limit on the amount you can overpay without incurring a financial penalty and, also, you need to ensure you let your lender know that you want the payment to reduce the term of the mortgage rather than simply reducing future monthly repayments.
Overpay on a regular basis
You can either choose to overpay by a set amount each month and let your lender know in advance to amend your payment schedule or, alternatively, you can opt to make ad-hoc overpayments on a month-by-month basis. Doing this gives you the freedom to just make the standard payment on months when your other outgoings are likely to be higher. Again, you need to check whether you are allowed to make regular overpayments on your mortgage repayments by checking the terms and conditions with your lender
Reduce the term when you remortgage
With most people remortgaging every two-to-five years as their mortgage deal comes to an end, there is an opportunity to chip away at the term of the mortgage during this process. If you commit to reducing the mortgage term by an extra year each time you remortgage - if you can afford to do so and/or if you can get a better deal - you will end up paying your mortgage off much earlier and save a lot in interest payments. It's worth bearing in mind that shortening the mortgage term in this way means you are committing to a higher mortgage payment every month. This offers less flexibility than simply choosing to overpay.
Consider an offset or flexible mortgage
Flexible mortgages let you overpay your mortgage by as much as you like, when you like, without having to pay any kind of early repayment charge or penalty. They also let you underpay or take mortgage holidays, giving you a high level of freedom to manage your finances to suit you.
An offset mortgage, meanwhile, works by linking a savings account with your mortgage account. The money in your savings pot is offset against your mortgage balance, which means you only repay interest on your mortgage debt minus the amount you have in savings. In turn, you won't earn interest on your savings that are used for offsetting. For example, if your mortgage is £100,000 but you have £50,000 in the savings account linked to your mortgage, you only pay interest on the £50,000 difference between the two.
Should I overpay my mortgage?
While most mortgages allow you to overpay by up to 10% of the mortgage balance each year, either as a lump sum or in regular, smaller overpayments, it's important to consider whether this is the right option for your circumstances. The appeal of being mortgage-free earlier and potentially making savings on interest payments is understandably enticing, but you need to consider:
- Can you reasonably afford to overpay? If you overestimate how much you can comfortably afford to overpay without impacting your standard of living or creating financial pinch points elsewhere, it is easy to put yourself in a difficult financial position. If you commit to overpaying at the beginning of the month but find yourself slipping into your overdraft by the end of the month, you may need to rethink your overpayment strategy.
- Have you got a sufficient "rainy day" fund? A general rule of thumb is to have the equivalent of six months' worth of your monthly outgoings in savings, often referred to as an "emergency fund". This gives you a cushion if you were to fall on hard times, perhaps through redundancy, ill health or a relationship break-up. While you may be tempted to put regular lump sums towards paying off your mortgage, you need to keep in mind that - unless you've got a flexible mortgage - once that money has been paid in, you won't be able to easily get it out again.
- Do you have more expensive debts that you could pay down instead? Using any extra cash to overpay your mortgage when you have other, potentially more expensive, debts could be unwise as you may save more money by paying off debts that attract a higher rate of interest.
- Would your money work harder by putting it elsewhere? If you can get a savings account that offers a higher rate of interest than the rate you are paying on your mortgage, you could earn more by leaving the money there, rather than using it to make a dent in your mortgage debt. Don't forget to factor in any tax you may pay on the interest paid on your savings.
How much can I overpay on my mortgage?
For most fixed rate, tracker or discount mortgages you can overpay 10% of the outstanding balance per year during your mortgage deal period without being penalised. However, when your mortgage deal comes to an end and you move to the lender's standard variable rate, you are usually permitted to overpay by as much as you like. Bear in mind that although there is no limit to how much you can overpay, the interest rate you are liable to pay will be much higher, meaning you may be better off remortgaging to a better deal.
As an example, during your mortgage deal period on a £100,000 mortgage, you can typically overpay by £10,000 per year without having to pay an early repayment charge. It is important you check this applies to your mortgage by asking your lender.
If you overpay more than the limit, or if your lender doesn't allow overpayments, you may have to pay an early repayment charge of up to 8% of the amount overpaid, so it is wise to get written confirmation from your lender of what you are allowed to do first.
How much can I save by overpaying on my mortgage?
The time and money you can save by overpaying your mortgage by even a small amount per month is remarkable. In the table below, we show what you could gain by paying off a set amount every month for the life of the mortgage. This is based on a repayment mortgage of £100,000 over 25 years at 4.5%, with the interest rate remaining the same for the life of the product.
|3 years 6 months
|6 years 1 month
|8 years 1 month
|9 years 8 months
|11 years 0 months
|12 years 1 month
|13 years 10 months
|15 years 2 months
|18 years 10 months
How do I overpay my mortgage?
If you decide to overpay your mortgage on a regular basis or with a lump sum, or a combination of the two, you will need to contact your lender to let them know. In doing so you can check:
- Are you allowed to overpay by the amount you want to without incurring an early repayment charge?
- Will your overpayment go towards reducing the overall term of the mortgage rather than reducing future payments?
- Is your lender anticipating the overpayment? It may think it has been made in error, which could lead to administrative problems
- Can you amend your standing order for your mortgage repayment if you want to or are you required to maintain a set monthly overpayment?
Is it better to overpay my mortgage or save instead?
As discussed above, the basic principle is, that if you are earning more interest from your savings account than you are paying for your mortgage, you should consider keeping your money in savings. If the interest you are paying on your mortgage is greater than the interest that you can earn on your savings, it is probably best to overpay your mortgage, assuming you are able to keep within your lender's limits.
Overpaying your mortgage vs savings example
You have £10,000 savings in an account paying 4%, netting you interest of £400 per year.
Your mortgage rate is 6%, meaning you are paying £600 per year on £10,000 of the debt.
If you pay off £10,000 from the mortgage, you will make a saving of £200 per year
For basic-rate taxpayers, the personal savings allowance enables you to earn up to £1,000 in interest, tax-free. This means that for most people it's easy to calculate if you are better off keeping your money in savings or paying off a chunk of your mortgage. It can become more complicated for higher-rate taxpayers, who have a £500 allowance and additional-rate taxpayers, who do not get any allowance, particularly if they have large amounts in savings. These individuals, need to work out the after-tax rate on their savings to get an accurate point of comparison against how much they are paying in interest on their mortgage.
Should I overpay my mortgage or reduce the mortgage term?
As the ultimate goal is to pay your mortgage off early, you may consider asking your lender to reduce your mortgage term, which increases your monthly payment. This serves the same purpose as overpaying monthly or in chunks, but it does mean you are tied into paying that increased amount for the life of the mortgage. This could be problematic if your financial situation changes and you struggle to make future repayments. With overpayments, you can simply go back to paying the original repayment and, in fact, may be more likely to be approved for a mortgage payment holiday, as you will have built up a strong history of responsible repayment.
In this table we show you the amount your monthly repayment goes up by for every year you knock off your mortgage term. This is based on a repayment mortgage of £100,000 over 25 years at 4.5%, with the interest rate remaining the same for the life of the product.
Mortgage payment increase based on term reduction
|Number of years taken off a 25-year term
How to get help when considering overpaying your mortgage
An independent mortgage broker can provide tailored advice and help you work out whether overpaying your mortgage is the right thing to do. They can also search the whole of the mortgage market to find the best deals for your circumstances. VouchedFor* is a website that can help you find and compare local mortgage brokers. The site allows you to search based on the services offered as well as their fees, location and most importantly reviews so you can get a sense of client feedback.
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