Q Last summer, I secured a five-year fixed-rate mortgage and managed to avoid the rising interest rates. Looking ahead, I want to be proactive and make as many overpayments as possible, considering the potential challenges in the next five years. Will it make a difference how I choose to overpay? Would it benefit me more to make a monthly payment or a larger lump sum at the end of each year?
RH
A If you had mentioned a “larger lump sum at the start of each year,” I would have recommended the lump sum approach. However, if your options are between making monthly overpayments to gradually reduce your outstanding mortgage and waiting until the end of the year to lower your mortgage balance, I would say that monthly overpayments are more advantageous. By making monthly overpayments, you reduce the amount of interest you pay. It is important to note that both approaches assume that there are no penalty charges for overpaying excessively.
Before you begin making overpayments on your mortgage, it is crucial to find out the annual overpayment allowance provided by your lender. This refers to the maximum amount you can overpay each year without incurring any early repayment charges. Generally, fixed-rate mortgages allow you to overpay up to 10% of the mortgage loan, although a few lenders extend this limit to 20%.
It is important to carefully review the details to avoid exceeding your lender’s limit. For instance, Nationwide building society sets the overpayment limit at 10% per year based on the original loan amount (applicable to all mortgage products reserved on or after 29 May 2013, excluding standard mortgage rate and base rate mortgages with no limits). Therefore, the maximum overpayment amount remains constant throughout the mortgage term.
On the other hand, HSBC, Santander, and Yorkshire building society apply the 10% limit to the outstanding balance each year, resulting in a decreasing overpayment capacity. With HSBC, the limit is reset annually based on either the date of mortgage account opening or the date of switch to a fixed rate. For Santander, the limit applies to a calendar year, meaning it resets on January 1st.
Lastly, make sure to communicate with your lender that you want your overpayments to reduce your mortgage term rather than just lowering your monthly payments.
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