With average savings rates falling for five consecutive months, would you better off plunging extra cash into overpaying your mortgage?
As we enter the final quarter of 2019, savers are still being punished with interest that lags behind inflation, while borrowers are benefiting from cheaper rates on mortgage deals.
With this in mind, you might be tempted to overpay your mortgage, potentially cutting months or even years off your term, and saving you thousands in interest payments.
Here, we explain the pros and cons of overpaying your mortgage and offer advice on how much interest you can earn on savings accounts.
Fewer than half of mortgage holders overpay
As part of the 2019 Which? mortgage lenders satisfaction survey, we asked 3,587 homeowners if they overpay their mortgage.
Just over three quarters (77%) of respondents told us that having the option to overpay was important, but less than half (46%) said they had overpaid in the past year.
Overall, 25% of homeowners overpaid on a monthly basis, while 22% said they did so as a one-off payment.
Overpay or save: what should you do with a lump sum?
First of all, let’s look at your options if you’ve come into some money and have a lump sum that you can either save or use to overpay your mortgage.
Currently, the best one-year savings accounts offer rates of little more than 2%, meaning that a lump sum of £2,500 will only gain £52 in interest in the space of a year.
It’s possible to get much better yields, but you’ll need to lock your money away for longer. Saving it for five years will give you the best rate:
|Account type (best rate)||Interest on £2,500 deposit||Interest on £5,000 deposit|
|One-year (2.07% – Al Rayan Bank*)||£52||£104|
|Two-year (2.32% – Al Rayan Bank*)||£119||£237|
|Three-year (2.42% – Al Rayan Bank*)||£188||£376|
|Five-year (2.35% – Gatehouse Bank*)||£311||£623|
Source: Rates from Which? Money Compare. 3 October. *These products are from Sharia-compliant banks, which pay an Expected Profit Rate (EPR), meaning the eventual amount you’ll earn in interest isn’t guaranteed.
If you instead used this money to overpay your mortgage, you could cut your deal’s overall term and avoid thousands of pounds in interest.
Based on a £200,000 25-year mortgage with an interest rate of 2.45% (the current average two-year fixed-rate), you could theoretically make the following savings:
|Lump sum overpayment||Approx. money saved on interest||Number of months cut from mortgage term|
How much difference do monthly overpayments make?
Of course, not everybody has thousands of pounds to save or spend in one go, so let’s look at the options available for people considering overpaying by a few hundred pounds each month.
If you’re looking to maintain control and want the option to save different amounts each month, you’ll need an instant-access savings account. Interest rates on these accounts are very low, with the current table-topping deal at 1.45% (the Marcus account from Goldman Sachs).
There’s no guarantee you’ll keep this rate beyond the first 12 months, but the good news is you can take your money out and switch to a better deal whenever you wish.
To give you an idea of how much you could save, let’s assume you can pay £250 or £500 a month into a savings account with an ongoing rate of 1.45%.
As you can see, by depositing £250 a month into an instant-access account, you’ll only make £20 in interest in the first year, meaning the overall benefits are negligible.
|£250 monthly deposit||£500 monthly deposit|
If you opted instead to overpay your mortgage, the benefits would depend on how long you kept up these extra payments for.
Based on a £200,000 loan over 25 years, if you overpaid your loan by £250 every month for three years, you could knock nearly £10,000 off the overall balance.
|Year||Remaining balance (no overpayment)||Remaining balance (£250 monthly overpayment)||Remaining balance (£500 monthly overpayment)|
- Find out more: our mortgage overpayment calculator shows what overpaying could mean for your mortgage term and interest
Do all mortgages allow overpayments?
Data from Moneyfacts shows that of the 6,747 residential mortgages currently on the market, 78% (5,317) allow overpayments of up to 10% of the balance per year, with the majority allowing both lump sum and/or monthly payments.
Just 6% of deals allow no overpayments at all.
While 10% a year is by far the most common limit, some lenders set their limits at 5%, and others place a cash limit on how much you can overpay by – for example, £500 a month.
Despite so many mortgages allowing overpayments, not everyone can afford to make these and some people simply choose to put their money elsewhere.
Is overpaying your mortgage a no-brainer?
In a time of low rates on savings and cheap mortgage deals, it can make sense to overpay in order to cut your mortgage term, but there are a few things you’ll need to consider first.
If you plunge extra money into your mortgage, you won’t be able to get it back very easily. So if you’re worried about stretching your finances, you might be better off overpaying in a more ad-hoc way, on months where you have extra cash left over.
The most important thing is to ensure you’re not left without an emergency fund if you circumstances change suddenly. As a general rule of thumb, keep enough money in an easy-access account to cover three months of essential expenses (such as your mortgage, household bills etc).
Before making a decision on whether to overpay, take a holistic view of your finances. If you have other debts from things like personal loans or credit cards, you’re likely to be better off prioritising paying these off, as the interest they charge will usually cost you more than the amount you’ll save by overpaying your mortgage – and almost definitely more than you’d earn from a savings account.
Alternatives to overpaying your mortgage
Remortgaging to a better deal
It’s a great time to remortgage, with cheap deals available across the board.
The main issue is that you’ll need to wait until the end of your introductory rate period or fixed term, as many mortgages come with high early repayment charges if you leave before this time is up.
If you have some extra cash, you could consider overpaying in the meantime to give you an even better chance of switching to a great deal when the time comes (as the best deals are available to people borrowing lower proportions of the property’s value).
- Find out more: our LTV calculator shows what percentage you’ll need to borrow
Reducing your mortgage term
If your primary aim is pay off your mortgage more quickly, you could ask your provider to shorten your mortgage term.
This will increase your monthly repayments, so both you and the lender have to be certain you can afford the extra cost.
Switching to an offset mortgage
Offset mortgages are less common than they once were, but they’re still available from some lenders.
These deals involve saving money into an account that’s linked to your mortgage. The amount you’ve saved will then be taken off the mortgage balance before interest is calculated.
- Find out more: mortgage types explained