What are the main advantages of making mortgage overpayments?

Homeowners overpaid their mortgages by a record £6.7 billion in the final three months of 2022.

It marks the first time overpayments have exceeded £6 billion in one quarter since records began in 1999.

According to the Equity Release Council, the total value of mortgage overpayments reached £23.3 billion last year.

The jump in overpayments is likely to have been triggered by rising interest rates as the Bank of England tries to bring down stubbornly high inflation.

By making mortgage overpayments, homeowners reduce the amount they owe, helping to offset some of the impact of higher borrowing costs.

What are mortgage overpayments?

Mortgage overpayments refer to the money you pay to your lender that’s above the standard monthly repayments you have to make.

You can generally make them as either a one-off lump sum payment or by increasing the amount you pay each month over your mortgage term.

Most lenders will allow you to make overpayments of up to 10% of the outstanding amount you owe each year without incurring a penalty, with some allowing you to repay as much as 20%.

What are the main advantages of making mortgage overpayments?

There are many advantages to making mortgage overpayments.

The main one is that it reduces the amount of interest you pay over the lifetime of your mortgage.

For example, if you borrow £200,000 over 25 years at an interest rate of 4%, you will pay a total of £116,702 in interest.

But if you increase your monthly repayments by £100 a month, from £1,055 to £1,155, you will pay only £98,681 in interest, saving you just over £18,000.

Not only that, but you will also repay your mortgage three years and five months sooner, meaning you will be mortgage-free quicker.

What other benefits are there to mortgage overpayments?

Making mortgage overpayments can also help to offset the impact of rising interest rates.

For example, if you have a £200,000 mortgage on which you are currently paying interest of 2%, your monthly repayments will be £848.

But if you are coming to the end of your deal and need to remortgage, your monthly repayments will jump to £1,055, based on a best-buy mortgage rate of 4%.

However, you can offset some of this increase by overpaying your mortgage to reduce the outstanding amount you owe.

For example, it you make a 10% overpayment reducing your outstanding mortgage to £180,000, based on the example above, your new monthly repayments will rise to only £950.

If you are able to make a 20% overpayment, the impact will be even bigger, reducing your new monthly repayments to £845 – broadly in line with what you are currently paying.

Another advantage of making overpayments is that it reduces the amount you owe relative to your home’s value. Lenders call this your loan to value (LTV) ratio.

Banks and building societies typically reserve their best deals for people with an LTV of 60% or less.

Even if you don’t qualify for one of the best deals, making overpayments could still help you move into a lower LTV tier, enabling you to benefit from a lower mortgage rate.

Finally, if you are struggling to keep up with your mortgage payments, lenders are often more likely to grant you a payment holiday if you have made overpayments in the past.

How to overpay your mortgage

There are two ways to make overpay your mortgage. You can either make a lump sum one-off overpayment or smaller, regular overpayments.

Both types of overpayment have benefits, and the most important thing is to only do what you can afford.

But if you are struggling to decide what to do, making one-off overpayments tends to have a bigger impact on your mortgage.

For example, if you take out a £200,000 mortgage with a 4% interest rate, making a one-off overpayment of £20,000 at the beginning of the term will save £30,179 in interest.

It will also mean you repay your loan three years and 11 months early.

By contrast, making overpayments of £100 a month on the same deal will save you just £18,020 in interest, even though the amount you are overpaying will amount to £25,900.

It will also knock three years five months off your mortgage term.

Can you overpay an interest-only mortgage?

When you overpay a repayment mortgage, you reduce the total amount you owe, which means you’ll pay less interest on your mortgage and you’ll pay it off more quickly.

When you overpay on an interest-only mortgage – and it is possible to do this – you don’t get the same benefits.

With interest-only mortgages, you’re only ever paying the interest on the loan, rather than reducing the actual debt itself.

Overpaying an interest-only mortgage can help to reduce future interest payments or the overall interest you pay, but it can’t help to pay down the overall debt you owe.