Overpaying your Mortgage - Is it the right choice for you?
If you’re in the fortunate position of having extra funds available, it can be difficult to know the best way to make use of them. The choices can seem overwhelming: should you pay down your mortgage, boost your retirement savings, invest in ISAs? How do you make sure you get the most value from your money?
Why make additional mortgage repayments?
Making mortgage overpayments can be a very tempting option. Interest rates on savings continue to be very low, with MoneyFacts.co.uk reporting that the average rate on easy access savings accounts fell further in 2020, to a rate of just 0.19% on 1 December 2020. The average interest rate on long term fixed savings also fell, leaving the average interest rate on a five-year fixed rate bond at a mere 0.97%.
Faced with these historically low interest rates, many homeowners prefer to pay more than the minimum payment on their mortgage, either as a lump sum or as regular payments. Decreasing the outstanding mortgage balance shortens the repayment term and as a result, reduces the total amount of interest paid, since interest is calculated in relation to the outstanding balance. Mortgage overpayments allow homeowners to pay off their mortgage earlier and for a lower overall cost than they may have projected when taking out the loan.
But are mortgage overpayments always the answer? Here are a number of factors you should consider when deciding whether or not to make overpayments on your mortgage:
Mortgage overpayments vs cash savings
Although it can be satisfying to see your mortgage balance drop, your first financial priority should always be to ensure you have a cash emergency fund. Experts advise having at least three to six months of living expenses in an easily accessible account. Having this cash on hand can help you and your family navigate tough times, from emergency repairs and unexpected bills to illness and lack of income. If you don’t yet have a robust emergency fund, consider building one before making mortgage overpayments.
If you do have an emergency fund you’re comfortable with, turn your attention next to other debts you might have besides your mortgage, such as credit cards and loans. Although the total amount owed may seem insignificant next to your mortgage balance, the interest rates are likely to be far higher, meaning these are more expensive debts to carry. Reducing or clearing those balances may be more beneficial than making mortgage overpayments.
Mortgage overpayments vs mortgage protection and insurance
Although the prospect of reducing your mortgage debt can be attractive, a higher priority should be placed on making sure you have adequate protections and insurance in place now.
If you don’t yet have comprehensive life insurance, critical illness cover and/or income protection insurance, consider allocating part of your surplus funds to ensuring you and your family are adequately protected before making mortgage overpayments. Having these policies in place can ensure your family will be taken care of should the worst happen, or that your mortgage will be paid should you find yourself unable to work due to illness.
Mortgage overpayments vs retirement savings
In addition to an emergency fund, saving for your retirement should be high on your list of financial priorities. A healthy pension pot will not only provide you with a more comfortable retirement, it will also give you a much higher degree of control over when, how and potentially even where you retire.
The earlier you start to save for your retirement, the larger your fund will be when you do choose to retire. Before making mortgage overpayments, it’s always a good idea to check all your options, including ensuring you have adequate protection, building a tax free investment portfolio or investing for your retirement. Speaking to one of the team here at McCrea can give you a clearer picture of your options and help you make the right decision.
Mortgage overpayments and repayment penalties
Before paying significant sums of money to your mortgage company, it’s essential that you take the time to check the terms and conditions of overpayments on your mortgage. While terms vary, it’s common to see overpayment penalties imposed on homeowners who overpay more than a set amount of their outstanding balance in any one year. Usually, overpayments are limited to up to 10% of the outstanding balance before penalties are applied.
The more you can reduce your outstanding balance during the early years of your mortgage, the more you will benefit in the long run. With a larger outstanding balance on a relatively new mortgage, you’ll be able to contribute a higher overpayment while still staying under your repayment penalty limit. If you have a lower outstanding balance on a mortgage that’s closer to the end of its term, it’s less likely that you’ll be able to make any meaningful difference by making overpayments and will be more likely to run into overpayment penalties.
Mortgage overpayments and remortgaging
If you plan to remortgage in the future, you will find the more attractive mortgage switching deals are available to those with lower balances and more equity in their property. In these circumstances, it can be helpful to have made mortgage overpayments in the past, where your solid payment history can also help demonstrate that you are a low risk for future lenders.
If you plan to remortgage your property, perhaps at the end of a fixed rate period, making a few years of mortgage overpayments now could help you secure a better deal in the future.
Mortgage overpayments vs offset mortgages
One way to balance the availability of your savings with the desire to reduce the interest paid on your outstanding mortgage balance is to opt for an offset mortgage as opposed to making mortgage overpayments.
An offset mortgage works by holding your mortgage and savings with the same provider. The amount of your savings is offset against your mortgage balance, and you only pay the interest on the difference between the two. For example, with savings of £50,000 and an outstanding mortgage balance of £150,000, mortgage interest will only be charged on the £100,000 which is not offset by your savings. It’s worth noting that you do not receive any interest on the amount held in your offset savings account. However, any funds held there remain instantly accessible should you need them.
Offset mortgages are not the answer in every instance. Offset mortgages generally charge higher interest rates than standard mortgages and are only suitable for homeowners with sufficiently high savings balances to make this worthwhile. It is vital to speak to an independent professional to decide if an offset mortgage might be right for you.
Are mortgage overpayments right for you?
Ultimately, the question of whether you should make mortgage overpayments depends entirely on your unique circumstances. The answer will vary for each homeowner based on your financial goals, other commitments and long-term plans. To help you see how mortgage overpayments could fit into your personal financial plans – or to make a start on developing those plans – why not get in touch for a free no-obligation consultation?