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In recent months, many savers have struggled with relatively low interest rates. In fact, according to data from Moneyfacts, as of 13 May, the highest return on an easy access savings account was only 1.1%.
If you don’t want to hold too much of your wealth in cash, one alternative you may have considered is to overpay your mortgage instead. This can potentially make a significant dent in your debt but it’s important to remember that this may not always be the right decision for you.
With that in mind, read on to find out some of the most important pros and cons to bear in mind if you’re thinking about overpaying your mortgage.
Pros of overpaying
You can pay off your debt more quickly
As you might imagine, one of the most obvious benefits of increasing your monthly mortgage payments is that you can settle your debt much more quickly. If you want to see how much it can help by, the Nationwide overpayment calculator can be a useful tool.
For example, let’s say you have a £200,000 repayment mortgage over a term of 20 years, with a 3% interest rate. According to the calculator, by increasing your monthly payments by only £100, you could shave two years and two months off your mortgage term.
Paying off your debt more quickly can be a great way to gain more peace of mind, as you have one less thing to worry about.
You could save a large amount of money in interest payments
Another benefit of overpaying your mortgage is that you could save a large amount of money in interest payments.
Using the example in the section above, according to the calculator if you overpaid by £100 each month then you would have to pay £58,403 in interest payments, saving you £7,804 in interest when compared with just making your normal monthly repayment.
As you can see, overpaying can potentially help you to save a considerable amount of money in the long term.
The interest that you save may be higher than returns on your cash
In recent months, interest rates on many savings accounts have been considerably below the rate of inflation. This is why you may be tempted to overpay your mortgage instead, as the interest saved on the loan may be higher than the interest earned on your cash.
As we mentioned earlier, according to Moneyfacts the highest return on an easy access saver as of 13 May was only 1.1%. Even in the long term, this low interest rate may mean that your cash doesn’t grow much at all.
Furthermore, if your money doesn’t rise in line with the rate of inflation, which stands at 9% in the year to April 2022 according to the Office for National Statistics, it may lose value in real terms.
Cons of overpaying your mortgage
It may be more sensible to use your spare money as an emergency fund
While increasing your monthly repayments can benefit you in the long term, doing so could make you more financially vulnerable in the short term. This can be especially true for young people, as they’ve had less time to build up their wealth and so tend to be more vulnerable to shocks.
In recent months, there has been a sharp increase in the cost of living. For example, according to government figures, gas prices rose by 28% in the year to March 2022, while electricity rose by 18%.
With this in mind, it may be more sensible to hold onto any spare cash and use it as an emergency fund in case you run into any unexpected problems. Having one in place can help you to absorb financial shocks and ensure that they don’t affect your ability to keep up with mortgage repayments.
Paying off other debts first can save you more money
Overpaying your mortgage can save you money in the long term, but you may also want to consider paying off other, more expensive, debts first.
Credit cards are a great example of this, as according to MoneySuperMarket, the average card charges an Annual Percentage Rate (APR) of around 19%. At such a high rate of interest, your debts can easily spiral if you don’t pay them off quickly.
While it can be tempting to overpay your mortgage, since it is probably the largest debt you owe, sorting your smaller but more expensive debts first can often be more useful.
You could incur a charge by overpaying
A final issue to consider is that if you have a mortgage with a fixed, capped, or discounted interest rate, you may be limited on how much you can overpay by. If you exceed this threshold then you could incur a charge, which would erode any long-term saving you could make.
Typically, this limit stands at around 10% of your remaining mortgage balance. For example, if you had £200,000 left to pay on your mortgage, you may be able to overpay by £20,000 each year without triggering a charge.
Of course, it’s important to bear in mind that the limit tends to vary between providers. This is why it’s important to carefully check the terms and conditions of your contract before overpaying.
If you incur a charge, it can make the strategy of overpaying less effective, which is why you may benefit from seeking professional advice first before you act.
Get in touch
If you’re considering overpaying your mortgage and want to know whether it’s the right decision for you, we can help. Email us at office@verve-financial.com or call 0330 320 5048.
Please note:
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
