Overpaying your mortgage can save you thousands if you can afford it

It’s always worth saving for a rainy day but have you thought about using any spare cash to pay down your mortgage?

With inflation heading downwards and energy prices coming down you may find that you have some spare cash at the end of the month and using that towards your mortgage could end up saving you thousands of pounds.

An overpayment is any additional payment you make over your usual monthly mortgage payment and can either be a one-off lump sum or a regular overpayment made throughout the year.

If you can afford it, no matter how small, overpaying can save you money on the total amount of interest that you pay and should also help you clear your mortgage balance quicker.

Key Benefits

By reducing the outstanding balance of your mortgage faster, you decrease the amount of interest charged over the life of the loan. This can lead to significant savings, especially over a long-term mortgage.

Overpaying increases your equity in the property faster and shortens the term of your mortgage, meaning you'll pay off the loan sooner and have financial freedom from your mortgage debt earlier.

Then there’s the emotional benefits too. Reducing your mortgage balance can provide a sense of financial security and reduce the stress of carrying long-term debt.

And of course, having a lower mortgage balance means you can potentially access a wider range of more competitive deals when it comes to remortgaging.

Example

Let's assume you purchased a property worth £280,000 with an 85% mortgage, meaning you initially borrowed £238,000. The mortgage is a five-year fix at an interest rate of 5.02%.

Overpaying your mortgage by £200 per month on a property worth £280,000 with a mortgage of £238,000 at 5.02% can save you approximately £3,501.47 in interest over five years. Increasing the overpayment to £400 per month can save you approximately £7,052.57 in interest over the same period. Additionally, these overpayments will also shorten the overall mortgage term, bringing additional long-term savings.

Basic Mortgage Details:

• Property value: £280,000
• Loan amount: £238,000 (85% of £280,000)
• Interest rate: 5.02%
• Term: 25 years (assuming a typical mortgage term)
• Monthly payment (estimated): £1,409.52

Making the standard monthly payment over five years the total interest payable would be £56,978.92.

But what about if you could pay an extra £200 per month? That would mean a monthly payment of £1,609.52.

By making a consistent overpayment of £200 each month, you would reduce the principal amount owed faster.

Over five years, or 60 months, £200 turns into £12,000 which would reduce the principle amount owed directly, meaning the interest you pay is calculated on the reduced balance which is shrinking by £200 per month. Over the five-year period, total interest with overpayment would be £53,477.45.

So to work out the interest saved: £56,978.92 - £53,477.45 = £3,501.47

Don't get caught out

When considering overpayments, it's essential to check your mortgage terms for any overpayment limits or penalties. Many mortgages allow overpayments up to a certain percentage of the loan balance per year without incurring penalties.

Overpaying your mortgage isn’t for everyone but not overpaying your mortgage can have several potential downsides, particularly in terms of financial costs and long-term planning.

Without overpaying, you'll pay more interest over the life of the mortgage because the outstanding balance remains higher for longer and likely be in debt for the full 25-year mortgage term.

This can affect future financial planning, especially as you approach retirement age, since you may still have significant mortgage payments.

And remember, not overpaying means it takes longer to build equity in your home, which can be a disadvantage if you plan to sell or remortgage.

While the money not used for overpaying your mortgage could potentially earn more elsewhere, if it’s left in low-interest savings account you’ll miss the opportunity to reduce your higher mortgage interest costs.