Mortgage overpayments have reached their highest levels in over two decades due to rising interest rates, as homeowners strive to reduce their debts. Many individuals with extra funds are opting to decrease their outstanding balance in order to tackle the surging rates that often result in substantial bills once their fixed-rate period ends. However, numerous banks are currently offering excellent savings account deals. Therefore, is it more advantageous to overpay your mortgage to mitigate the risk of bill shock, or should you save any surplus money in an account?
How Does It Work?
Mortgage repayments are not fixed and can often be increased to reduce the overall owed amount, resulting in a shorter mortgage term. The past two years have witnessed financial market turmoil, with interest rates soaring from 0.1% to 5% since December 2021. Consequently, lenders have hiked borrowing costs, burdening countless individuals transitioning from affordable fixed-rate deals with significant payment spikes.
To alleviate the weight of their debt, a growing number of people are making overpayments. For instance, following the September mini-budget, the Equity Release Council reported a record-breaking £6.7 billion in overpayments during the last quarter of 2022, surpassing the £6 billion mark for the first time since 1999. L&C Mortgages broker David Hollingworth advises those on a fixed rate mortgage to make preparations for when it expires.
Hollingworth states, “Although rates could ease back if inflation is brought under control, there’s no guarantee as to when that may be, and it doesn’t signify a return to the historic lows of base rates that we’ve experienced in recent years. Adjusting the monthly budget allocated to the mortgage can maximize the current deal’s value. This can be achieved through monthly overpayments or saving a regular amount to accumulate funds for the opportune moment to reduce the mortgage.”
The advantage of overpaying is twofold: it reduces the total owed amount and eliminates interest payments. Financial advice site NerdWallet’s Adam French emphasizes that the higher the interest rate, the greater the savings from overpayments. For example, on a £250,000 mortgage debt with a 25-year term, a one-time overpayment of £10,000 at 2% interest saves £6,257 in interest and shortens the term by a year and three months. However, on the same mortgage at 6% interest, a £10,000 overpayment saves £31,723 over the mortgage’s lifetime and reduces the term by two years and one month.
What Are the Limits?
Lenders typically impose limits on overpayments for fixed-rate deals, usually capping it at around 10% per year. However, this can vary depending on the lender. According to Hollingworth, most deals include an early repayment charge during the fixed-rate period but provide a certain degree of overpayment flexibility without penalties. This amount is usually 10% of the balance per year, though lenders like NatWest, Metro, and Atom Bank offer limits of up to 20%. Alternatively, borrowers can avoid restrictions or fees by overpaying once they transition to the standard variable rate (SVR) mortgage that usually follows the fixed-rate period. In theory, individuals can come off a fixed rate, make an overpayment, and then sign up for another fixed-rate deal.
John Charcol mortgage adviser Sophie Waugh emphasizes that having the necessary funds can ensure the absence of limits or fees when switching from a fixed rate to an SVR mortgage. For instance, someone with a £200,000 mortgage and a remaining term of 25 years would pay £1,609 per month at an 8.49% SVR. By comparison, if they opt for a new two-year fix at 6.18%, the monthly payment would be £1,310. Although this represents a significant increase compared to their most recent payments, a £20,000 overpayment would decrease the monthly payments to £1,448 and £1,179, respectively.
Why Not Just Save?
Savings account and ISA rates are currently at their highest in years, prompting individuals to consider the potential returns from saving instead of using the funds to pay off their mortgage. As a general rule proposed by Martin Lewis’s MoneySavingExpert, if your mortgage rate is close to or higher than the savings rate, it is advisable to overpay. Hollingworth highlights the need to compare savings rates with mortgage rates and factor in any tax on the interest. Although the personal savings allowance often mitigates this issue, rising rates could impact taxpayers, especially those in higher brackets.
Overpaying can also lower the loan-to-value (LTV) ratio of the property, potentially enabling borrowers to secure more favorable rates when obtaining a new fixed-rate deal. However, overpaying may not be suitable for everyone, particularly those who need to maintain sufficient emergency savings. Additionally, it is crucial to prioritize the repayment of more expensive debts, such as credit cards or loans, before considering mortgage overpayments. MoneySavingExpert advises borrowers committed to overpaying to inform their lender of their intention to reduce the mortgage term, after which overpayments can usually be made through online banking.
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