Don't be a Scrooge with your mortgage!

Give your lender a present this Christmas, and receive an even bigger one back

Your mortgage lender is probably not at the top of your Christmas present list.

Indeed, if you have any extra cash this festive season, an extra bottle of champagne or perhaps a new Christmas party outfit probably feels like more of a priority than your mortgage right now.

But if you are taken over by an irrepressible desire to offer a little extra to your lender, it could be the best Christmas present you ever give -- because it will save you a lot of money in the long run.

Mortgage Scrooges

Of course you could just pay your mortgage lender the amount they ask for each month -- most borrowers do. In the last 18 months your monthly repayments may even have fallen if you are on a variable deal, as interest rates dropped to a record low in March 2009, and have stayed that way since.

If you would rather pocket the difference, of course that’s absolutely fine. Simply pay your mortgage lender what you owe each and every month and, assuming you have a capital repayment mortgage, you will have paid off your mortgage in full by the end of your term, no sooner, no later.

Change your future

However, just like Dickens’ Scrooge you can change your future by being a little more generous. If you decide to pay a little more to your mortgage lender this Christmas, for example, you could end up completing your mortgage term ahead of schedule.

This is because of a simple but effective feature of many mortgages -- the ability to overpay. Take advantage of it and you could save thousands of pounds and shave years off your mortgage term.

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Overpaying means paying your lender more than they require, either by means of a lump sum payment or a regular monthly overpayment.

When you overpay the excess comes straight off your mortgage balance, meaning you owe less. And then a very clever thing happens. Because many lenders now calculate interest on a daily basis (as opposed to annually) the amount of interest you owe will fall, as a result of your smaller debt.

This means that less of next month’s mortgage payment needs to go towards paying interest, so more of it can go towards paying down your debt.

If you overpay again you speed up this process so that you are reducing your mortgage debt more and more quickly, and therefore you owe less interest still on this smaller debt.

It’s a virtuous circle where you end up chomping away at your mortgage debt at breakneck speed compared to when you just pay your set amount.

How much can you save?

The example below assumes you took out a 25-year repayment mortgage.

If you owe £200,000 and your interest rate is 4% your monthly repayments will be about £1,056.

But if you could afford to pay an extra £150 a month you would pay off your mortgage a staggering five years early and save an incredible £23,000 in unpaid interest.

The benefits of overpaying are explained further in Shave years off your mortgage.

Who can do this?

Most mortgage borrowers will be able to make limited overpayments as the majority of high street lenders now offer it as standard across their mortgage range. You will probably find that you can overpay a maximum of 10% of your outstanding balance each year.

Some mortgages are specifically billed as ‘fully flexible’ and if you have one of these you may be able to make unlimited overpayments. With these deals you may even be able to ‘underpay’ in the future if you run into financial trouble, or take a payment holiday for a month or two (provided you have overpaid by enough to do so).

There are two other important benefits to overpaying. If you hold your cash in a savings account you are taxed on the interest you receive, but if you use that money to overpay your mortgage you do not incur tax (since you haven’t earned any interest on it).

Secondly, by paying down your debt you can help to reduce your loan-to-value ratio (increasing your equity) and this can open up far better remortgage deals to you in the future.

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Overpaying makes sense for many borrowers, but if you really want to max your money you can go one step further with an offset mortgage.

Total flexibility

An offset mortgage uses the same concept of overpaying but goes one step further.

Rather than actually overpaying money into your mortgage, you simply link up your savings (and sometimes your current account) to your mortgage. Your offset provider treats all the money you have in credit as one massive overpayment on your mortgage, and charges you less interest accordingly. And the best bit is that you don’t actually have to overpay your savings. They are kept in a separate pot and you still have access to them. But you are effectively overpaying.

In exchange for this you sacrifice earning any interest on your savings and current account. But because your mortgage interest is often higher than the interest you earn on your savings (which you are then taxed on), it’s actually better use of your money to avoid paying interest at your mortgage rate.

Offsets are a great option for many borrowers, especially for those with substantial savings earning a paltry rate of interest. They are explained in more detail in Offset your mortgage and save £42,000.

So if you feel like discarding your Scrooge-like tendencies and want to embrace overpaying your mortgage, do it. You could be giving yourself the best Christmas present ever -- freedom from your lender sooner than you expected.

Below are some of the best current offset deals:

13 fantastic offsets

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