Paying more to your mortgage lender can mean great savings, but you will lose access to your money.
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Why overpay?
Overpaying sounds strange but it actually makes sound financial sense. By paying your lender more than necessary you reduce your overall mortgage debt more quickly, and because you're charged interest on that debt, the interest you owe also reduces.
Over the long term this can have a dramatic effect on your finances, potentially saving you thousands of pounds and cutting the term of your mortgage by years.
It can also help you build up an equity buffer in your home, as the more you pay the more of your home you own. This could prove invaluable should you want to remortgage in the future.
Lenders offer their best deals to those with the greatest equity, so overpaying can give you future access to cheaper mortgage rates.
Easier than ever?
Current low interest rates mean that more borrowers than ever are able to overpay, without feeling the financial pinch.
In 2007 the base rate stood at a whopping 5.75% and the average rate on an outstanding variable rate mortgage was 6.42%.
Now the base rate has been at its all-time low of 0.5% for over five years, and mortgage rates are extremely competitive (particularly for those with a lot of equity).
This gives borrowers greater potential to overpay their mortgage because, for many, their interest rate and monthly repayments have plunged in recent years. Rates have fallen massively, so by simply maintaining their previous payment many borrowers are quite easily able to overpay.
Who overpays?
According to the CML some 2.3 million borrowers have paid off more than they need to since 2005, which is around 34% of all mortgages taken out in that period. And the amount overpaid is a massive £31 billion!
The trade body found that borrowers who took out mortgages in 2008 have been particularly significant overpayers. The reasons for this are clear. A third of lending in 2008 was tracker mortgages and at the time they were priced at a very narrow margin to base rate (less than one percentage point above base rate).
As the base rate has plummeted, so many of these 2008 borrowers have seen a truly massive fall in their monthly mortgage commitment, making it very easy for them to overpay now.
Those with more equity in their homes are also more likely to overpay, as are those who have borrowed to modest income multiples. In other words the less stretched you are, the more likely you are to be willing and able to pay more to your lender, which makes sense.
Borrowers with offset mortgages are, unsurprisingly, significantly more likely to have overpaid. The ability to pay off the mortgage faster is a key selling point of offset products, so it stands to reason that borrowers would use them for this purpose.
Is it a good idea?
Overpaying is an excellent idea for many borrowers. It helps you to build equity in your home, which means that better deals will become available to you when you remortgage. And it saves you money, because by owing your lender less money, you are charged less interest. The cumulative savings are not to be sniffed at.
However, there is one big issue with overpaying. It can mean you lose access to that money, which isn’t very helpful if you need it in the future.
Putting your extra money into an easy access savings account or ISA may not be too appealing with interest rates currently so low, but at least your cash is there should you ever need it. Whether you lose your job, your cars packs in or you are faced with an unexpected expense, having money you can get your hands on quickly is invaluable.
Of course some mortgage lenders will allow you borrow back your overpayments, or underpay in the future, providing you have built up an overpayment buffer. But it’s essential that you double check your future access to money you overpay – even with a fully flexible mortgage.
There have been recent reports of lenders refusing to allow borrowers to borrow back their overpayments, even where this was a feature of the mortgage.
Suggestions that some lenders are keeping hold of overpayments, even if the borrower is on schedule to repay the loan on time, are clearly concerning for borrowers who have already overpaid significantly, especially if you don’t have sufficient funds in a separate savings account.
Of course, each lender is different so make sure you check your lender’s policy on borrowing back overpayments or making underpayments in the future.
Money you overpay could be gone, or at least tied up in your property, until you come to sell. It might be working hard for you in your mortgage account, but that won’t be much good if you need it now. Only overpay what you can afford to be without.
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This guide aims to give information, not advice. Always do your own research and/or seek out advice from an FCA-regulated broker (such as one of our brokers here at lovemoney.com), before acting on anything contained in this article.
Your home or property may be repossessed if you do not keep up repayments on your mortgage.
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