Overpaying your mortgage: your rights
Rising house prices and not getting onto the property ladder until much later in life means more of us face paying for a home hanging over us when we might have hoped to be debt-free, and relaxing at last.
Yet most of us have a vague idea that if we could overpay the mortgage, we'd clear the debt several years earlier, and save a tidy sum at the same time.
It's an option worth considering - but it's not always the right one.
Overpaying: Why do it?
1. It can knock years off a mortgage
Take, for example, someone with a 25-year £150,000 mortgage, with an interest rate of 5%. If they paid a lump sum of £5,000, that one overpayment would have the effect of ending the debt 19 months earlier.
Alternatively, overpaying by a smaller amount, but every month, can have an even more dramatic effect: if the person above instead chose to pay an extra £500 a month, indefinitely, they'd repay the loan almost 13 years sooner.
2. ...which means paying less over time
The longer you take to pay off a mortgage, the more you end up paying in the long term, as the interest on the outstanding balance continues to add up. So overpaying, whether in lump sums, or month by month, can significantly reduce the overall cost.
Take the £150,000 mortgage above. Making that one £5,000 lump sum payment would save more than £11,500 in interest over the (shorter) term of the mortgage.
The person choosing to pay off £500 more per month would save more than £63,000 in interest.
For someone with a mortgage on a house costing the UK average - £271,000 in October 2014 - under the same terms as above, here's a breakdown of how much difference overpaying each month could make:
|Overpayment per month||Interest saved||Repaid how much sooner?|
|£100||£25,900||Nearly three years|
|£300||£61,300||Six years, nine months|
|£400||£74,084||About eight years|
|£500||£84,700||Nine and a half years|
3. It's more economical than saving
The interest earned by the money in our bank and savings accounts is aligned with the Bank of England's base rate - which has been 0.5% since 2009.
While that's great for mortgages, it's terrible for savings. At the time of writing, you can expect to earn just 1.3% with an instant access account. The best one year fixed rate account offers interest at 1.95%, and the best five year fixed rate offers 3.10%.
Mortgage interest is almost always charged at a higher rate - at the moment, typically around 4% - so by saving rather than paying off the mortgage, you're effectively losing money.
When not to overpay
Overpaying isn't for everyone, particularly if any of the following apply.
You have more expensive debts
This may sound counter-intuitive, but while your mortgage is probably your biggest debt, it's not your most expensive - and it always makes financial sense to pay off more costly debts first.
Credit cards and store cards with high APRs should come first. Loans and other forms of borrowing are also likely to have interest rates much higher than that of your mortgage.
There's more on repaying loans more quickly here.
Your pension is lacking
But thanks to tax relief, compound interest, and the market's ability to outperform savings long term, sorting out a pension is one of the most sensible, intelligent things we can do.
The older you are, the more you need to put in to get a decent return when you do retire - so bolstering your pension is better done sooner rather than later - and it's one of the few ways of saving that's more effective than paying off debts.
You have no emergency fund
...or life insurance.
People with dependants need to consider how mortgage payments will be covered should anything happen to them.
According to Which?, a 54-year-old non-smoker taking out £100,000 of life insurance over 10 years would pay premiums of less than £1 a day. Younger people can expect to pay less, or get more cover for the same price.
Less pessimistically, it still makes sense to have some money kept by elsewhere, as life insurance won't help in the case of illness or a change in employment.
The general advice is to have enough money put by to last at least three months if you weren't working. Keep it in a different account, in a different institution, so it can't be used to cover an overdraft or other debts.
Overpaying: Think about...
How much can you overpay?
It varies from lender to lender, but most will allow you to pay an extra 10% a year before applying penalty fees, and some - not many - allow overpayments of up to 20%.
The percentage of what, though, is another matter.
For example, Nationwide allows overpayments of 10% on the original balance of the mortgage - so the person in our first example could overpay by up to £15,000 more every year.
But those with mortgages from Britannia are only allowed to pay up to 10% of the previous year's outstanding balance - so the further into the mortgage you are, the less you can funnel into the remaining debt.
Check with your lender how much is okay, and what the penalty fees for going over this amount actually are.
Overpay, don't increase payment amounts
This applies to regular overpayments only.
The advice here is that where possible, agree the standard repayment, but also set up a separate standing order or direct debit for the overpayments. That's because there's a subtle difference between overpaying and paying more.
With the suggestion that interest rates may rise this year, all non-fixed rate mortgage payments will increase - and if your overpayment is included in the standard monthly sum, your lender may well expect the extra on top of the higher amount.
Keeping the two separate means you have the flexibility to adjust how much you overpay, so your total monthly expenditure on the mortgage needn't change.
Your regular payments
On a related note, check what happens to those regular payments if you do overpay.
Some lenders will reduce your normal payment to compensate for what you've overpaid, or automatically shorten the number of payments you're expected to make.
If the latter happens, you're in the same situation as those mentioned above - paying more rather than overpaying - which you might not always be able to afford.
When to overpay
Interest on a mortgage can be calculated daily, monthly, quarterly or yearly.
For regular overpayments, you needn't worry too much - but if the interest is calculated yearly, and you want to make one-off payments, find out when the calculation date is.
This is one of the other times saving is a good option. Put that money in the best-paying savings account, ISA, or new high interest current account you can find - and then arrange the overpayment to occur just in time for the calculation date.
Alternatively, if the amount you want to pay off is substantial, ask your lender if they'll do a recalculation after the payment - many will.
Another problem with one-off payments is that they tend to be frowned upon within the introductory or special rate periods - usually the first five years.
Particularly with fixed rate, tracker or discounted mortgages, overpayments in the first few years can incur hefty charges, typically between 1% and 5% of the amount being paid off early.
So our £150,000 mortgage holder from earlier, wanting to pay off £5,000 in one go, could expect to be charged between £50 and £250.
As ever, check with your lender for details. Most will reduce the penalty charge as the introductory period draws to an end. For example, HSBC charges "1% of the amount repaid early for each remaining year of the fixed rate period, reducing on a daily basis".
These are really the holy grail. Flexible mortgages allow you to overpay, and sometimes even take some of the money back if you need it, without penalty.
Offset mortgages are more like giant overdrafts than separate debts. Any money you have in other eligible accounts will count towards reducing the mortgage balance - and therefore the interest chargeable.