Pros and cons of overpaying your mortgage

As major lenders hike mortgage rates yet again, many homeowners may be ruling out making voluntary extra payments on their home loans.

But overpaying on your mortgage if you can afford to can “save you money in the long run”, said MoneySuperMarket. You’ll pay less interest overall, “since you’ll clear your debt quicker”. And if you need to remortgage, you may be able to secure a better rate – which could be more important than ever.

The Bank of England is expected to raise rates to a 15-year high of at least 4.75% next week, and markets are betting on rates “settling closer” to 6% than 5% by the end of the year, said the BBC's Faisal Islam. Recent hikes have already triggered a “deluge of mortgage repricing" among major lenders.

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HSBC and Santander are already withdrawing deals and raising rates, which have surged by 0.5% for some fixed-rate home loans in the past few weeks alone. You may not feel the impact of interest rate rises yet if you are already on a fixed deal, said MoneyHelper, but it may be worth “taking advantage of the low rate you’re currently enjoying” by making overpayments.

Overpaying may not be for everyone though, and there are various pros and cons to consider.

1. Pro: pay off mortgage sooner

Borrowers can usually make a lump sum overpayment, add to their monthly payments, or do both. By overpaying, you will “pay off more of the money you originally borrowed quicker than you first calculated”, said NerdWallet, meaning you clear your mortgage sooner. For example, if you owe £100,000 on a mortgage with a 20-year term and an interest rate of 3%, paying an extra £200 as a regular monthly payment could save you £11,596 in interest over the lifetime of the loan and cut the term by six years and seven months.

2. Con: other debts could mount up

It may be tempting to be mortgage-free as fast as you can, but a “crucial rule of debt repayments” is to clear high-interest credit cards and loans before overpaying your mortgage, said MoneySavingExpert. Interest on these products is usually more expensive and you can end up in deeper debt if you fall behind on repayments.

3. Pro: better returns than savings

With most savings rates still below inflation, “the money you save on mortgage interest often beats the returns you would get from putting the cash in a savings account”, said The Times Money Mentor.

According to Confused.com, if your mortgage interest rate is higher than your savings interest rate, you should “consider making the overpayment” as it could be a better use of your spare cash. For example, £5,000 in a savings account with 1% interest would earn £50 in a year. But if you had £5,000 left on a mortgage with a 3% rate, you would pay £82 interest. In this case, overpaying is worth it, as “the interest you’d get from savings would be less than the savings you’d make by not having to pay the interest on your mortgage”.

4. Con: can’t get that money back

When you put cash into a savings account, you can access it if and when you need. That’s not the case when you put money towards your mortgage. Make sure you don’t “drain any emergency savings you have” for things such as fixing a broken boiler or funding expensive car repairs, said Go.Compare. The comparison website recommended trying to keep enough set aside to cover six months’ essential expenses.

You could also be missing out on returns if money spent on overpayments were invested instead, especially if you are young and have time to build a nest-egg, warned Michael Taylor in the Financial Times. If you overpay a mortgage with a rate of 5%, you save five pence for every £1 you overpay. But if you invest that money in assets, “it’s not unlikely you could earn more than 5% over the long run”, said Taylor.

5. Pro: better remortgage deal options

Overpaying will “chip away much more quickly at what is owed and could help you qualify for a lower loan-to-value deal when your fixed rate ends”, said ThisisMoney.co.uk. The lower your LTV, the lower the interest rates you can access. “So overpaying on your mortgage could mean that you get an even cheaper deal when you come to remortgage,” said Unbiased.

6. Con: early repayment charges

Lenders typically have limits on how much you can overpay each year – usually up to 10% of the value of your loan, although NatWest currently allows overpayments of up to 20%. Most fixed-rate and discounted mortgages also have penalties, known as early repayment charges (ERC), which kick in if you pay the loan off before the end of the term. This “would easily wipe out any interest savings”, said MoneyWeek.

However, in some cases, it may be worth paying the fee in order to move to a mortgage that saves you money in the long term by locking in a rate now before costs potentially rise further.

Marc Shoffman is an award-winning freelance journalist, specialising in business, property and personal finance. He has a master’s degree in financial journalism from City University and has previously worked for the FT’s Financial Adviser, the financial podcast In For a Penny and MoneyWeek.