Should you overpay on your mortgage as interest rates rise?
In recent weeks, you’ve probably seen the news headlines that interest rates have increased sharply, raising the cost of mortgages for millions of borrowers.
According to Moneyfacts, as of 26 October 2022, the average two-year fixed-rate deal stood at 6.50%. The average five-year fixed rate stood at 6.36%. It means that, in the space of 12 months, the average two-year rate has nearly tripled, while the average five-year fixed rate has more than doubled.
As mortgage rates rise, you may be wondering whether you should use some of your savings to repay a lump sum to your mortgage. Or, you may be wondering if regular overpayments might be beneficial. Read on to find out more.
Overpaying your mortgage could help you save money on interest
If you decide to overpay, you will likely pay less mortgage interest overall.
An example from The Times Money Mentor shows that if you had a £250,000 loan with a 3.5% interest rate, over 25 years the interest payable would be £125,596. However, over 15 years, you would only pay £71,768.
Using savings to pay off all or part of your mortgage could also have the benefit of reducing your monthly outgoings. Your alternative is to keep your repayments the same and reduce the outstanding term instead.
One factor to consider is whether you could earn more money on your savings than the interest you are paying on your mortgage.
If your cash savings are earning less than your mortgage interest rate, using some of them to pay back a lump sum could see you better off overall.
You may end up with better equity
Even if you can’t pay off the entire mortgage, overpaying means you would own more equity in your home. This could put you in a better position when it comes to remortgaging.
If your “loan-to-value” has fallen, you could benefit from a lower interest rate if you decide to switch when your current deal expires.
Even though the benefits might look appealing at the current time and overpaying your mortgage might seem like a good idea, there are many things to consider first.
The impact of overpayment charges
Before you make any overpayments, it is important to factor in any fees that you may incur for doing so. Most mortgages will allow you to overpay by a set amount each year and many providers have set this limit to 10% of the mortgage, though some have a lower limit than this.
Paying back more than the limit set by your mortgage provider could end up with you paying an unwanted early repayment charge, which means the overpayment may not have saved you money in the long run.
The importance of an emergency fund
Before you use your savings to pay a sum off your mortgage, it can be beneficial to retain a sum as an “emergency fund”.
Having an emergency pot of money for an unexpected one-off expense is always handy as can help prevent you from having to take on more debt.
An emergency fund can also be valuable if you are unable to work for a while, or you lose your job. During the current climate of a recession and a high cost of living, retaining some money as an emergency fund could be a consideration before you repay some of your mortgage.
It could be a good idea to pay off other debts first
If you’re looking to repay some of your borrowing, it can pay to consider high interest debts before your mortgage.
It’s likely that your mortgage costs you less interest you may be paying on other types of credit. Paying off these more expensive debts first could help you to clear these, saving you money in the long run.
Adding to your pension could be more beneficial
Instead of overpaying your mortgage, it might benefit you more to increase your pension contributions. This could help you get closer to achieving your retirement savings goals.
All the extra money you put into your pension becomes invested and has the potential to grow.
Get in touch
If you have savings and you’re not sure how to use them, get in touch. We can consider your overall financial situation and look at the best ways to make the most of your assets.
Email us at firstname.lastname@example.org or call 0330 320 5048.
This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.