Save Thousands With Your Pay Rise!

Don't let your pay rise disappear -- why not use it to shave years off your mortgage?

One thing I tend to get a lot of emails about is how to make the most of a pay rise or bonus. Pay rises in particular can equate to relatively modest sums after tax, which can easily disappear into the ether. So here's a particularly satisfying method of using the extra cash -- why not use it to overpay your mortgage?

Overpaying

Now, I know a lot of people will be thinking that their mortgage payment is their biggest bill, so why on earth would you want to pay any more money to that pesky lender? Well, the answer is simple -- paying more into a repayment mortgage means that you'll be hacking away at that debt even faster. And as that loan is typically accruing interest on a daily basis, the quicker you can pay it off, the less interest you'll have to pay. Plus, you'll own your home much sooner -- and wouldn't a mortgage free life be fantastic?

Let's take a look at an example:

Say Stephanie earns an annual salary of £25,000 and receives a 4% pay rise -- £1,000 per year. For argument's sake we'll assume that after basic rate tax and national insurance this equates to a rise of £50 per month.

Stephanie and her husband Jack have a 25-year, £120,000 repayment mortgage, at a rate of 5%. They currently pay just over £701 per month, so after 25 years they would have paid £210,452 -- £90,452 of which being interest.

Now, Stephanie and Jack are quite keen to pay off their mortgage early, and after checking with their mortgage lender they find that they can overpay up to 10% of their loan, each year, with no penalty. Stephanie decides to use her £50 monthly pay rise to overpay the mortgage, increasing their payments to just over £751 each month. She also tells her lender that she wishes this extra money to be classed as a capital repayment (i.e. it will work to reduce the term of the mortgage, not the monthly payments).

As a result, Stephanie and Jack would end up paying their lender a total of £197,836, saving themselves a whopping £12,616 in interest and shaving 3.1 years off their term, meaning the house would be theirs in just under 22 years.

What's more, Jack also received a pay rise equating to an extra £75 per month, which he, too, decides to use against the mortgage. Overpaying a total of £125 per month would increase their payments to just over £826. And as a result, this reduces their total repayment to £184,613, saving £25,839 in interest, and shaving nearly 6½ years off their term. Stephanie and Jack would therefore be mortgage free in just over 18½ years. Blimey!

Obviously this is a very simple example, but it does show that overpaying, even by relatively small sums can be substantial when used against a large loan such as a mortgage. Of course, increases in the cost of living tend to take up most of our pay rises, meaning that even with an increase we're no better off. But if you can afford to, putting that pay rise into your mortgage can be very worthwhile.

If you're interested in overpaying, remember to check with your lender first to ensure you can do so with no penalty. It's also worth checking when the interest on your loan is calculated -- most modern mortgages work on a daily basis, meaning that each pound you pay in goes to work right away.

If your mortgage is calculated on an annual basis, ask what date your payments go in on. Then, save the money you would like to overpay by in a high interest savings account and pay it in on that date -- you'll keep the interest earned during the year, not your lender.

Many people forget that even though we sign up for a 25-year term there is no reason why we should stick to this. If you have any extra cash each month, or what appears to be a small pay rise, using it against your mortgage can make a huge difference and save you thousands of pounds in interest, each year.

Find our more about overpaying in our Mortgage Centre.

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