Is it worth overpaying on your mortgage this year? 4 important factors to consider

The allure of being mortgage-free is undeniable, and for many, overpaying on your mortgage could be the route to getting there quicker. Overpaying can reduce interest costs, shorten your loan term, and accelerate the growth of your home equity. 

However, it’s important to weigh these benefits against other options, such as saving or paying off other debts. Ultimately, the decision of whether to overpay is a personal one that requires careful consideration of your individual financial circumstances and long-term goals.

Read on to explore four important factors to consider when deciding whether overpaying on your mortgage is the right choice for you. 

1. Overpaying on your mortgage could reduce interest costs

One of the most significant benefits of overpaying on your mortgage is the potential to reduce the interest you pay over the life of your loan. 

By making overpayments beyond your regular monthly instalments, you directly reduce the principal amount owed. This means you’re borrowing less money, resulting in lower interest charges since interest is calculated on the outstanding balance.

Even small overpayments can accumulate substantial savings over time. 

Let’s assume you took out a £500,000 repayment mortgage 10 years ago with a 4.5% interest rate. According to Mortgage Calculator, the interest you’d pay over the 25-year life of your mortgage could cost you £333,749 (assuming you pay the same interest rate throughout the term). 

Additionally, Mortgage Calculator’s reduction-over-loan-term graph shows that after 10 years, you likely owe £363,292 and have 15 years left on your mortgage. 

Here’s what it could look like if you were to make regular monthly overpayments starting now:

Source: HSBC

As you can see, the more you contribute, the larger the long-term savings could be. However, even a small monthly contribution can make a difference.

For lump sum overpayments, as opposed to regular monthly contributions, here’s what you could save: 

Source: HSBC

Keep in mind that these figures are illustrative and may vary depending on factors such as your initial loan amount and the interest rates throughout the life of your loan, which can change.

2. You could shorten your loan term instead of directly overpaying on your mortgage

An alternative to making extra payments is to shorten your mortgage term. This means you’ll pay off the loan faster, but it will increase your monthly payments. You would typically do this when remortgaging to avoid early repayment charges (more on this later), so your lender will assess your affordability to ensure you can comfortably manage the higher instalments.

While this may sound similar to overpaying your mortgage directly, there is a key difference: 

• Overpaying your mortgage gives you the flexibility to change or manage additional payments. 

• Shortening your term means you’re locked into higher monthly payments, but there will be guaranteed consistency.

Both instances will likely result in you paying less interest overall, but your personal circumstances will determine which is right for you. A mortgage adviser is well-placed to offer impartial advice based on your unique financial situation.

3. You may be able to build equity faster by making overpayments

Overpaying on your mortgage could significantly accelerate the growth of your home equity. This is because each payment directly reduces the principal amount owed, meaning you’re borrowing less money. As the principal balance decreases, your equity – the difference between your home’s market value and the outstanding mortgage – increases proportionally.

For example, if your property is worth £700,000, and you owe £500,000 on your mortgage, your home equity would be £200,000. Remember that home values can fluctuate, influencing your overall equity.

A higher equity balance could improve your borrowing power, as you may be able to access more favourable terms or secure a larger mortgage if you move. Many people also choose to use the equity in their homes as a way of funding renovations, which could increase their property’s value in the long term. 

You may also find that having more equity in your home acts as a valuable safety net. In case of unforeseen circumstances, and where you don’t have protection in place, you may be able to access your home’s equity to manage other financial burdens. 

Accessing your home equity to cover other financial needs is not a decision to be taken lightly, so talk to a mortgage adviser before making this decision.

Having protection in place can help you avoid having to do this, so if this is a concern, consider looking at income protection, critical illness cover, or life insurance to help mitigate the financial challenges that could arise from illness, injury, or death.

4. Early repayment charges could negate the benefits of overpaying on your mortgage

As mentioned earlier, early repayment charges (ERCs) are fees that many lenders impose if you pay off your mortgage (or an agreed percentage of it) before the end date of your mortgage deal. The exact percentage may vary from lender to lender, but these charges can significantly affect the financial benefits of overpaying. 

ERCs are typically calculated as a percentage of your outstanding mortgage balance and will apply if you: 

• Pay off your mortgage early

• Remortgage to a new lender before your current deal ends

• Exceed overpayment limits specified in your mortgage agreement.

Significant overpayments followed by a substantial ERC could negate a portion of the savings you’ve achieved.

To avoid this, carefully review your mortgage agreement to understand the terms and conditions related to ERCs, including how much the charge is and when it applies.

If you want to make overpayments, try to stay within the limits detailed in your mortgage agreement. Otherwise, consider timing your overpayments with the end of your current deal, where ERCs may no longer apply. 

Be sure to discuss your overpayment plans with your adviser to understand any potential implications and explore options for minimising or avoiding ERCs.

Get in touch

Ultimately, overpaying on your mortgage can offer some significant benefits, including reduced interest costs, a shorter loan term, and faster equity growth. However, it’s crucial to weigh these benefits against other financial priorities. Consulting with a mortgage adviser can help you work out a course of action that suits your unique needs and circumstances.

If you’re interested in overpaying on your mortgage but don’t know where to start, please get in touch via our Contact Us page.