There are pros and cons of overpaying a mortgage, which Nick Mendes discusses below
Is the mortgage market turbulence getting you down? Have you got a mortgage-related question you need answering? Email in and we’ll get one of our experts to reply. Nick Mendes, mortgage technical manager at John Charcol, has given his advice to a reader below. If you have a question for our experts, email us at money@inews.co.uk.
Question: I locked in to a 2 per cent mortgage on my £200,000 three-bed semi in 2021. The deal was on a 25-year term, but the fix of course ends next year and I’ll pay far more. We have just under 35 per cent equity in the property but I’m currently wondering about dramatically overpaying this year to 40 per cent. Is it worth doing this? What are the pros and cons?
Answer: Locking into a 2 per cent mortgage in 2021 would have felt like a great decision at the time, given the historically low interest rates.
However, with that deal coming to an end next year, it is understandable to be concerned about the significantly higher rates you may face.
The primary advantage of making a significant overpayment is that it could allow you to access a better mortgage deal when you remortgage.
Most lenders offer their most competitive interest rates to borrowers with a loan-to-value (LTV) of 60 per cent or lower. By pushing your equity up to 40 per cent, you could potentially qualify for a more favourable rate than you would with 35 per cent equity.
Even a small reduction in your interest rate could translate into meaningful savings over the term of your mortgage.
Another key benefit of overpaying is that it directly reduces the amount of interest you will pay over the life of your mortgage.
By lowering your outstanding balance, you are effectively reducing the portion of your monthly payments that go towards interest rather than repaying the capital. If you choose to maintain the same mortgage term, this will mean lower monthly repayments, giving you more financial flexibility.
However, there are also considerations to bear in mind before committing to a large overpayment. Many lenders impose limits on how much you can overpay each year without incurring penalties, particularly if you are on a fixed-rate deal.
Typically, lenders allow up to 10 per cent of the outstanding mortgage balance to be overpaid annually without triggering early repayment charges. If you exceed this threshold, you may face a fee, typically around 1 per cent, as you are in the last year of your fixed-rate deal, which could erode some of the financial benefits.
It is also worth considering whether the money you intend to use for the overpayment could be better utilised elsewhere. If you have outstanding debts with higher interest rates, such as credit cards or personal loans, it may be more advantageous to clear these first.
Similarly, if your savings are earning a higher interest rate than your mortgage rate, it might make sense to keep the funds accessible rather than locking them into your mortgage. Having a financial cushion in savings can provide security in case of unexpected expenses or changes in circumstances.
Another factor to weigh is how long you plan to stay in the property. If you are considering moving in the near future, making a large overpayment may not be the best use of your funds, as you will have less liquidity available for a deposit on your next home or other expenses associated with moving.
Whether making a significant overpayment is the right decision depends on your financial position and long-term plans.
If your main objective is securing a better mortgage deal when you remortgage, then reaching 40 per cent equity could be a wise move. However, it is always advisable to check the terms of your current mortgage to ensure that you will not incur penalties for overpaying beyond the allowed limit.
Consulting with a mortgage broker and use online calculators could also help you determine the most effective strategy for your circumstances.