Shave years off your mortgage cost

One lender has announced that borrowers can now overpay 20% of their mortgage balance in the next year without penalty, which could save you thousands!

Lloyds Banking Group this week announced its variable rate mortgage borrowers are now able to overpay 20% of their mortgage balance between now and 31st March 2011 penalty free (provided they are still within their special rate period).

This new rule applies across the Group’s brands, so includes Lloyds TSB, C&G, Halifax, Bank of Scotland, and BM Solutions.

It means that clients can pay an extra 20% of their outstanding mortgage balance on top of their monthly repayments set by the lender, either as a lump sum or ad hoc overpayments during the year.

Most large lenders already allow borrowers to overpay up to 10% of their balance a year in addition to their monthly repayments, although some have caps of, say, £500 a month. Anything over and above your lender’s limit could leave you liable to an Early Repayment Charge of anything up to 4% of the mortgage balance.

So why has Lloyds now decided to double the amount it will allow borrowers to pay off penalty-free?

Maximum advantage

The lending giant says the move underscores its commitment to help its customers gain “maximum advantage” from the current low rate environment.

Related how-to guide

Cut your mortgage costs

Find out how to cut the cost of your mortgage by hundreds of pounds a month and become mortgage-free years earlier.

See the guide

According to Lloyds, mortgage repayments accounted for 32% of average post-tax earnings in the last quarter of 2009, down from almost half (47%) at the end of 2007. So many borrowers have more money left at the end of each and every month.

This gives you the perfect opportunity to reduce your mortgage debt more quickly by overpaying now. But why would you want to use your extra money to pay off your mortgage?

Here's why - whatever you pay over and above your agreed monthly repayment comes straight off your outstanding debt. And then a very clever thing happens.

Next month you will owe less interest because your debt is smaller. This means that a larger proportion of your standard monthly repayment can chip away at the debt again, reducing it further. Overpay again and you speed up this process because you reduce your debt again.

The less you owe the less interest you incur, and over the long term this can save you thousands of pounds in unpaid interest charges and cut years off your mortgage.

One in four borrowers already overpay, according to Lloyds Banking Group, and almost half (48%) of them say they are doing it to reduce the term of mortgage. Nearly a quarter of them (22%) want to pay less interest over the term of the mortgage.

But just how much time and money can you really save?

The facts that figure

On a £100,000 mortgage with an interest rate of 3.5%, overpaying by just £50 per month would reduce the term of a mortgage by three years and six months, as well as saving you £14,576.04 in total (made up of £7,557.24 in saved interest and £7,018.80 in saved mortgage repayments). If you can afford to overpay more, the savings are even greater as the table below highlights:

Impact of overpaying on a £100,000 repayment mortgage at 3.5%

Source: Lloyds Banking Group

Not only does this save you time and money, it can also help reduce your debt as a proportion of your property’s value (your loan-to-value ratio). And this can open up far more deals to you if you decide to remortgage in the next year or two.

The best mortgages are still reserved for those with equity of at least 25%, so by reducing your debt you can help yourself bag a more competitive mortgage.

Easy savings

Even better, because many people’s mortgage repayments have dropped in the last year, all you need to do to overpay is maintain your repayments at their previous higher level (assuming you can still afford to).

Lloyds Banking Group claims that there has never been a better time for the majority of people to overpay their mortgage. It says the average mortgage repayment has dropped by around £188 per month. And those on tracker mortgages have done even better – on average they are just over £400 a month better off. This means they have the chance to maximise this extra cash by continuing to pay it into their mortgage.

Will double overpayments be popular?

Lloyds certainly thinks so, saying one of the reasons that it brought in the new rule was following a raft of phonecalls from consumers saying they wanted to be able to reduce their mortgage debt by overpaying more.

It commissioned research into this, which concluded that over 60% of borrowers would definitely consider overpaying or increasing existing overpayments if they were given the chance to overpay without a penalty.

Of course, by allowing customers to double the amount of extra money they pay into their mortgage, the lending group will also get a welcome cash injection over the next year, which is not going to do it any harm at all!

Either way, this new rule certainly helps those who have the money and the appetite to overpay their mortgage within the new limits. Borrowers who want to repay more than 20% would do well to look at fully flexible mortgages that allow unlimited overpayments.

Increasingly these come in the form of offset mortgages, which enable you to sacrifice earning interest on your savings in order to ‘effectively overpay’ that money into your mortgage. Offsets take the overpaying principle one step further as I explained in Homeowners: maximise your savings.

If you have the spare money overpaying your mortgage certainly makes sense and hopefully more lenders will follow Lloyds Banking Group’s lead of allowing borrowers increased flexibility over how quickly they repay their homeloans.

That way we could all maximise our money by overpaying our mortgages.

More: Five ways to make thousands from your home! | The street where homes cost £7m!