With many UK homeowners remortgaging on higher interest rates it’s been a commonplace for us to discuss the topic of overpaying mortgages with clients. Is this right for them & should they do it? Overpaying your mortgage should be a serious consideration if you have the cash as it can lead to some serious interest savings. Savings accounts are paying some of the best rates we’ve seen in years, so those with cheaper mortgages may wish to explore this option. The article below explores this topic in more detail.
The MUST do before hand:
Whilst overpaying your mortgage can be a useful step towards financial freedom it can also be a disaster if we haven’t laid the groundwork to do so below we outline our three MUST do actions before we go any further:
Action 1: Ensure a sufficient emergency savings pot.
Once you overpay your mortgage you no longer have the option of accessing the cash, it’s important that you keep enough cash on hand to meet any costs that may arise. If you’re made redundant or your boiler goes, do you have enough cash on hand to cover these expenses without having to take on debt?
Action 2: Clear other debts.
A crucial consideration is do you have any other debt with higher interest rates? If so you should probably look at the practicality of making repayments here first. This can include credit cards, car finance & even student loans.
In paying off the most expensive debt first interest doesn’t build up as quickly & we will clear the outstanding balance of your debts sooner.
Action 3: Check for over payment penalties.
The ammount you can overpay by will often depend on the type of mortgage you have:
- Standard Variable Rate (SVR) or trackers: You can usually overpay by as much as you want (do check if you’re on a tracker). The typical SVR mortgage will often have high interest rates and consumers can often save by simply remortgaging onto a fixed-rate.
- Fixed-rate or discount mortgage deal: Typically a lender will allow an over payment of up to 10% of the outstanding value per year, this should be checked with your provider.
Is overpaying right for me?
Rule Of Thumb: If your mortgage interest is roughly the same as your savings rate (or higher), then you should pay off the mortgage.
That’s because when it comes to savings, the reverse isn’t automatically true.
A higher savings rate could beat overpaying your mortgage, but it won’t always. It will depend on a number of factors, including whether you make a one-off overpayment or plan to make regular overpayments over the longer term, the size of your mortgage debt, how many years you’ve left to repay the mortgage and whether you pay tax on savings interest.
Overpayments don’t have to be big bucks. Even a regular monthly overpayment of £20, £50 or £100 can substantially reduce the interest you pay, shorten your mortgage term, and may even overshadow savings interest. This table shows the potential impact:
| Monthly Overpayment | Total Interest Saved Overpaying (£100,000 mortgage @ 4.5% over 25-years) | Interest if payment is held in savings account @ 4.5% |
| £10 | £2,470 | £2,006 |
| £100 | £20,010 | £13,357 |
| £1000 | £70,570 | £17,703 |
Additional factors to consider.
Whilst the above can make a compelling argument there are a few additional factors that may sway your decision on overpayments.
Factor 1: Tax
The interest that you earn on your savings may be subject to tax at income tax rates if you earn interest above your personal savings allowance.
If you’re unsure of this & how it works then we’d suggest reading our article on tax efficient cash savings.
Factor 2: Future Remortgages
Overpaying a mortgage will decrease your debt but also have the secondary benefit of improving your loan-to-value (LTV) – the percentage of the property value that is outstanding against your mortgage.
With more equity being held in your property the lenders have more security & as such offer a cheaper interest rate.
This doesn’t happen on a linear basis & is triggered at the following thresholds: 90%, 85%, 80%, 75% and 60%
Factor 3: Use of Pensions
Contributing to a pension can often be more advantageous than overpaying a mortgage. Pension investments grow tax-free, allowing your savings to compound without tax erosion. Additionally, contributions to a pension may qualify for tax relief, meaning you invest a larger initial amount, which further boosts compound growth over time. However, this approach carries risks, as pension funds are inaccessible until retirement, if your mortgage interest rate increases you may not be able to access the funds. Despite this, the tax advantages and potential for higher returns make pensions worth considering. We’d suggest seeking advice in this area before making a decision.
Factor 4: Offset Mortgage
An offset mortgage can be more beneficial than overpaying a mortgage or holding savings, as it allows you to use your savings to reduce the mortgage interest charged while keeping the funds accessible. The interest savings are tax-free, unlike taxable savings account interest, providing a significant financial advantage. However, offset mortgages typically come with a slightly higher interest rate, so you generally need a substantial amount of savings for the interest reduction to outweigh the higher rate, making this option most worthwhile for those with larger cash reserves.
Conclusion
Overpaying your mortgage can be a smart strategy, offering the potential to save on interest and own your home sooner. However, its effectiveness depends heavily on a thorough review of your personal financial situation, including income, savings, and future goals. To ensure this approach aligns with your needs, seeking professional financial advice is highly recommended.
The above does not constitute financial advice & the information provided may be subject to change, we advise seeking advice from a professional tax advisor.
About the author
Louis is a regulated independent financial advisor with a diploma in financial planning from the Chartered Insurance Institute. He founded his own financial planning firm in 2019 & has specialised in helping high earning individuals on all personal financial matters.
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