Overpaying on your mortgage now could be the key to financial freedom in later years.
A mortgage is often the largest financial commitment you will ever take on. But did you know that by making overpayments, you could potentially save thousands in interest, pay off your mortgage sooner, and reduce financial stress?
Fairstone Mortgage and Protection Adviser, Charlie Churcher, explores the benefits of overpaying on your mortgage and why it’s a smart financial move for many UK homeowners.
The Benefits of Overpaying on Your Mortgage
Paying off your mortgage faster
One of the most significant benefits of making overpayments is that you’ll clear your mortgage balance sooner. Becoming mortgage-free earlier means you can focus on other financial goals, such as retirement savings, investments, or travel.
Mortgage interest is calculated based on the outstanding loan amount. By overpaying, you reduce the principal balance, leading to lower interest payments over time. The earlier you start overpaying, the more you can save.
Say you have £150,000 left of a 20-year mortgage with a 6% rate.
If you overpay a lump sum of £15k (that’s 10%), you will pay off your mortgage two years and seven months early. Plus, you’d save £29,600 in interest.
Building equity in your home
Equity is the difference between your home’s value and your outstanding mortgage balance. By overpaying, you build equity more quickly, which can be beneficial if you plan to move, remortgage, or release equity later.
Overpaying could also mean clearing your mortgage early, leaving you with more disposable income which can create opportunities to save more, or put more away for your retirement, speak to an adviser who can provide the best solution and discuss your options.
You could access better mortgage deals
Overpaying your mortgage could help you cut your loan-to-value (LTV).
This is the proportion of your property price covered by your mortgage. If you’re overpaying your mortgage, you don’t just get the advantage of paying interest on a smaller amount of debt. Overpaying also means your loan-to-value ratio – that’s the percentage of the property value that you need to borrow as a mortgage – falls faster too, as you pay off more of your mortgage and build equity in your home. This means that when it comes to remortgaging, you may be able to get a cheaper deal than if you hadn’t overpaid.
It goes down if your property value goes up and as you pay off more of your mortgage. That’s why overpaying can help bring it down.
Therefore, if you have savings or you are overpaying month by month, it is worth speaking to a mortgage adviser to discuss the best ways of doing this in line with your personal circumstances and objectives, as doing so could reduce your mortgage borrowing and cut your loan-to-value (LTV) giving you greater access to cheaper rates.
A good reason to bring down your LTV is that lenders use this figure to decide which deals they’ll offer you.
The lower your LTV, the lower the interest rates you can access.
As a rule of thumb, the main thresholds are:
- 95% 90%, 85%, 80%, 75% and 60% LTVs: The rates at 60% would usually be cheaper than the 75% rates for instance.
- So, overpaying on your mortgage could mean that you get an even cheaper deal when you come to remortgage.
Increased financial flexibility
By lowering your mortgage balance, you improve your financial options. If you need to move, you might afford a larger deposit or qualify for a better mortgage deal.
Before making overpayments, check with your lender to ensure there are no penalties or limits on extra payments.
Offset mortgages
Offsets provide a middle ground between paying off a mortgage balance and having access to funds during your mortgage term. If you have additional funds to repay your mortgage but possibly need the cash to remain liquid, an offset could be a good option.
Overpaying regularly vs officially reducing the term
In many cases it’ll be better for you to overpay regularly without officially decreasing your mortgage term. That’s because overpaying regularly does almost exactly the same job as decreasing the term – both mean you pay more each month, you pay less interest, and your mortgage will be paid off sooner.
If you officially shorten the term, you’ll lock yourself in to a contract with higher monthly payments. So, if your income suddenly goes down, or your interest rate rises, you could struggle to meet the payments. Whereas if you’re overpaying, you can choose to stop those overpayments – giving you more wiggle room.
If after making an overpayment your lender tells you your mortgage term hasn’t been officially reduced – or that you’d need to pass an affordability test to shorten it – remember that overpaying has the same practical effect, but with that extra flexibility.
If you’re still unsure what to do, speak to a mortgage broker or an adviser.
They’ll give you a clear idea of your options and help you search out the best deals.
When overpaying check with your lender if there are any restrictions on how much you can overpay on an annual basis. Going over this threshold could cause you to incur charges.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.
