What are the financial benefits of overpaying my mortgage?
If you can afford to, and if your mortgage agreement allows it, overpaying your mortgage can be a financially astute move. The benefits of making overpayments can be substantial over time, potentially saving you thousands of pounds in interest and reducing the term of your mortgage.
What is an overpayment?
An overpayment is any lump-sum or regular payment you make on your mortgage, that exceeds the regular monthly amount required by your lender.
Does my mortgage allow me to make an overpayment?
Many (but not all) mortgages allow the borrower to overpay. The amount you can overpay varies and there may be associated charges if you exceed this amount. Typically, you can overpay up to 10% of your outstanding mortgage balance each year. If you exceed this limit, you may be charged penalty fees.
Check your mortgage agreement for information on overpayment limits and charges.
Reducing your monthly interest payments
The interest on your mortgage is calculated on the outstanding balance. By overpaying, you reduce this balance more quickly, meaning you'll pay less interest over the term of the mortgage.
Repayment mortgage
If, for example, you take out a £300,000 mortgage on a 5% interest rate over 25 years, your monthly payment will be approximately £1,750 per month.
The following are examples of how increasing your monthly payment can save you money and reduce your mortgage term:
| Monthly overpayment | Monthly repayment | Total interest saving | Total mortgage cost (Interest + capital repayment) | Mortgage paid off in |
|---|---|---|---|---|
| £0 | £1,750 | £0 | £526,320 | 25 years |
| £100 | £1,850 | £26,030 | £500,290 | 22 years 6 months |
| £200 | £1,950 | £46,00 | £479,920 | 20 years 6 months |
| £300 | £2,050 | £62,830 | £463,490 | 18 years 10 months |
| £400 | £2,050 | £76,390 | £449,930 | 17 years 5 months |
| £500 | £2,050 | £87,800 | £438,520 | 16 years 3 months |
What if I want to make a one off lump sum overpayment?
It’s not uncommon for people to receive a bonus, inheritance or other lump sum and decide to pay off a portion of their mortgage.
The following are examples of for lump-sum overpayments could affect a 5% interest mortgage with 20 years left on the mortgage term:
Repayment mortgage
| Lump sum overpayment | Total interest saving | Total mortgage cost (Interest + capital repayment) | Mortgage paid off in |
|---|---|---|---|
| £0 | £0 | £396,090 | 20 years |
| £10,000 | £16,200 | £379,890 | 18 years 9 months |
| £25,000 | £37,530 | £358,570 | 16 years 11 months |
| £50,000 | £66,520 | £329,570 | 14 years 2 months |
To compare mortgages, try our our mortgage calculator:
Why does overpaying have such a dramatic impact?
The principle behind the dramatic effect of mortgage overpayments on interest paid is compound interest, where interest is calculated on the initial amount borrowed plus the accumulated interest of previous periods. Reducing the outstanding balance through overpayments will decrease the amount of interest compounded over time.
Reducing the outstanding balance by overpaying also decreases the total interest charged over the life of the loan. With less interest to pay, more of your monthly payment goes towards reducing the outstanding balance - thus accelerating the repayment process and reducing the mortgage term.
Is this the whole story?
No. If you have the means to overpay on your mortgage, you might decide to put the extra money into a savings account. However, while the interest rates for mortgages and savings accounts can be comparable, the interest you earn on savings will be subject to income tax at the prevailing current rate.
Depending on your financial circumstances, the net benefit will typically outweigh the potential interest from savings after tax.
Reducing the mortgage term
Overpaying your mortgage allows you to pay off your loan sooner. This is particularly beneficial if you're aiming to be mortgage-free by a certain age or before a significant life event, such as retirement. Continuing from the previous example, the reduction of the term by over 3 years, means you achieve financial freedom quicker, allowing for more flexibility in your future financial planning.
Conclusion
Before making an overpayment, review your mortgage agreement or check with your lender for any restrictions or penalties. Some mortgages have early repayment charges, especially during the fixed-rate period.
Some lenders also allow you to ‘underpay’ or take a payment holiday if you’ve made overpayments, which can be a useful financial safety net. However, you should always make sure that overpaying your mortgage doesn't leave you unable to meet your other financial commitments.
