What is a Mortgage Overpayment?By Money Mage · · Mortgage, What Is, Frugality
Some mortgages permit you to overpay. Overpaying your mortgage can save you tens of thousands of pounds in interest.
Overpaying is a great way of reducing this long term burden on your finances.
Overpaying isn’t ‘lost’ money. It reduces your monthly outgoings, bringing forward Financial Independence. Imagine not having to spend hundreds or low thousands on a mortgage payment every month?
Look at the effects of mortgage interest:
The blue line shows mortgage interest over term if you overpay double every month. You can pay off a £130,000 25-year mortgage 14 years early. Saving £23,454 in interest.
Many argue you should invest rather than overpay. I’ll cover investing instead later.
Be careful when overpaying. Check Early Repayment Charges with your lender. Some mortgage companies permit overpayments. For example, 10% of the loan amount per year without charges. An unexpected Early Repayment Charge will wipe out any savings.
What if you are struggling with repayments? Are you on maternity leave? Suffering from ill health? Been made redundant? You may be able to arrange a Payment Holiday with your lender.
Your lender may permit you to reduce or pause your monthly payments.
Remember when you stop paying, you are still incurring interest on your loan. This can be a costly option.
If you have overpaid your mortgage payments may come from your Overpayment Reserve. Talk to your lender first.
Early Repayment Charges
‘How much can I overpay on my mortgage?’ This depends on your mortgage. Some mortgage companies permit overpayments. For example, 10% of the loan amount per year without charges. Check with your lender, or you may face Early Repayment Charges.
Early Repayment Charges are charges due to the lender if you pay some or all of your mortgage off during your mortgage Deal.
Early Repayment Charges often are hefty at the start of your deal length, and decrease over time.
Imagine you have a £180,000 5 Year Fixed but your job demands you move to a new city in the first year. You have to sell your home. You’ll have to repay the loan amount to Nationwide. In the first year of a 5 Year Fixed at Nationwide, the Early Repayment Charge is 5% - or £9,000!
A hefty charge, and one to avoid. Be wary and check your Early Repayment Charge clauses.
So you have heard you can overpay your mortgage. If your mortgage has an Overpayment feature, it is likely you can build an Overpayment Reserve. This is the amount you have overpaid to date.
Overpayment Reserves can sometimes be used to take a paid Payment Holiday. When you stop paying, your payments come from your reserve. You will have to check with your lender to arrange first.
Does overpaying my Mortgage reduce my monthly payments?
This depends on your lender. Often when overpaying you get to choose whether:
- Your overpayment reduces the length of your mortgage
- Your overpayment reduces your monthly payments
Check your lender’s terms.
Should I overpay my mortgage?
Whether you overpay your mortgage or not depends on three key questions:
- What is your attitude to risk?
- Are you looking to reduce your monthly expenses?
- Can your money earn more elsewhere?
What is your attitude to risk?
Are you risk-averse? Or do you mind taking a risk for the potential of future returns?
Are your savings in cash accounts or do you have investments where your capital is at risk?
Your attitude to risk will impact your decision. If you are risk-averse, paying your mortgage off early can save you tens of thousands in interest payments.
Are you looking to reduce your monthly expenses?
Paying off your mortgage will significantly reduce your monthly outgoings.
It won’t reduce your housing costs to £0. You’ll still have to spend on maintenance, servicing, and local taxes. Clearing your mortgage is one of the biggest dents in your monthly outgoings.
Lower monthly outgoings mean an easier to reach Financial Independence number!
Can your money earn more elsewhere?
Is it better to overpay my mortgage or save and invest? If I have £60,000, I can use it to a clear a 19 year, 2.14% mortgage. Should I clear the mortgage, or should I invest?
Many argue you should invest rather than clear your mortgage.
There are two choices:
- Clear your mortgage early. Save and invest what were your mortgage payments.
- Drag your mortgage out. Save and invest what you would have used to overpay.
Here are four cases to consider:
- Regularly Invest instead of Overpay
- Regularly Overpay double, then Invest
- Invest a Lump Sum instead of Overpay
- No overpayments, clear mortgage with a Lump Sum, then Invest
1. Regularly Invest instead of Overpay
I pay my £564/mo mortgage payments for 25 years. I can afford to overpay double every month. Instead of doing this, I invest £564/mo at 5% p.a over 25 years.. It grows to £337K
After 25 years, I have £130K+£337K = £467K
2. Regularly Overpay double, then Invest
I pay my £564/mo but I overpay my mortgage by double every month. I save and invest nothing for those 9 years. I have £130K when my mortgage is cleared after year 10.
For the remaining 15 years, I invest £1128/mo at 5% p.a. It grows to £302K
After 25 years, I have £130K+£302K = £432K
3. Invest a lump sum instead of Overpay
For 6 years, I pay my mortgage with no overpayments. I don’t save. 6 years into the mortgage, I come into some money through inheritance - £60K. My income drops at around the same time so I can’t save going forward either.
If I lump sum invest the £60K, at a growth rate of 5% p.a. over 19 years, I’ll have £154K. I’ll need to pay £564/mo for another 19 years.
After 25 years, I have £130K+£154K = £284K
4. Clear with a lump sum, then Invest
Consider case 3, but instead, I pay the mortgage immediately with the Lump Sum. I will have £564/mo lower outgoings for 19 years. If I invest £564/mo at 5% p.a I’ll have £214K.
After 25 years, I have £130K+£214K = £344K
The winner here is not so easy to pick.
In the simple case (1) regularly investing in the early years wins.
In the more complex case (4) clearing a mortgage with a lump sum frees cash, enabling regular investing going forward.
By clearing our 25-year mortgage in only 6 years we are now saving & investing what would have been our mortgage payments and overpayments. I reckon we’ll come out on top by taking this approach.
Use Money Mages’ Mortgage Overpayment Calculator (coming soon) to see how much you can save.
It’s possible to be mortgage free at 50, or even mortgage free at 35!
Being mortgage-free comes with big benefits:
- It’s a huge expense gone
- It’s a huge security blanket owning your home
But it’s also an opportunity cost. Can you put tens or low hundreds of thousands of pounds to work elsewhere? For better returns?
We cleared our mortgage in 6 years. But we also invested in the stock market via tax-efficient pensions. Don’t neglect your other savings & investments for mortgage overpayments.
Subscribe now, follow me on Twitter @moneymagery, stick by the Principles of Financial Independence and you’ll be mortgage-free in no time.
Sources and Attribution
- Low Interest Rates (c) LendingMemo, CC-BY