The mortgage overpayment hack that can cut your interest by thousands

A growing number of homeowners have turned their attention to mortgage overpayments in the last year as they look to fight back against higher interest rates.

Santander, one of Britain’s biggest mortgage lenders, reported a 78pc rise in the amount overpaid by its customers between 2022 and 2023 - but it’s not always the best course of action. 

Paying extra on your loan repayments can reduce the interest being clawed back by your lender and speed up the process of becoming mortgage-free.

Months or even years could be cut off your mortgage term, with minimal overpayments of just £10 making a difference in the long-run.

By weighing up the interest being charged by your mortgage lender, versus interest you’re paid on your savings, you could be better off squirrelling your cash into a savings account instead.

That’s where our calculator comes in.

Simply enter a few details about your mortgage, the amount you’re considering overpaying by, and how much you’re earning from your savings, and we’ll reveal which option could be better for your cash.

Overpaying your mortgage can save you tens of thousands in interest

Most lenders allow customers to repay up to 10pc of their mortgage balance each year without incurring an early repayment charge. NatWest is a notable exception as last year it increased its cap on overpayments to 20pc. 

The extent of the early repayment penalty varies depending on the lender. It’s usually a percentage of the outstanding mortgage – typically between 1pc and 5pc.

You can either commit to overpaying by a regular monthly amount, or pay as a lump sum whenever you have some cash to spare.

While mortgage rates have been trickling down in recent months, fixed term deals are still expensive compared to the low rates seen a couple of years ago, and paying down your home loan can have a big effect.

For a borrower with a £350,000 mortgage on the average two-year fixed rate of 5.55pc (as of January 30, according to Moneyfacts) and a 25-year term, overpaying by £200 a month would save £55,570 in interest and result in the debt being cleared four years and two months early.

In comparison, if you put the same £200 a month into a savings account that pays the current average easy-access rate of 3.18pc over 21 years – the amount of time it would take to pay off your mortgage with overpayments – you’d earn £21,354 in interest.

This suggests overpaying your mortgage could be a good choice, as saving £55,570 in mortgage interest may be preferable to the savings interest you’d earn.

Small overpayments can make a difference

Depositing just a little extra cash each month can make a dent in the long-term cost of your mortgage.

Using the same scenario as above, a £10 overpayment each month on a £3500,000 loan over 25 years would see you save £3,443 in interest. Two months will also be shaved off the overall mortgage term.

Figures from Santander show how a mortgage-holder can make use of the National Insurance cut brought in at the start of the year.

The bank said those earning between £60,000 and £100,000 a year will see an NI saving of £63 a month, which if put towards a £200,000 mortgage would save more than £15,000 in interest and take two years off the term.

Overpaying may help when you come to remortgage

Borrowers with more equity in their property may be able to secure a better rate when they come to remortgage.

“Overpaying isn’t necessarily going to be looked at more favourably by a lender as they will always want to see that the mortgage is affordable,” said David Hollingworth of broker L&C Mortgages.

“But it could reduce the loan-to-value (LTV) on the mortgage, which could open up a broader range of better rates. And a smaller mortgage should also mean that affordability is easier to meet – which again could help to open up the best choice of rates.”

When is overpaying not worth it?

Making the wrong decision between saving vs overpaying could cost you in the long run.

Right now some borrowers will still be locked into a super-low fixed mortgage rate, meaning you could be better off taking advantage of a top savings rate instead.

For example, Ulster Bank currently pays 5.2pc on an easy-access account.

The same borrower with a £350,000 mortgage on a fixed-rate of 2.2pc (secured when interest rates were much lower) and a 25-year term could save £16,737 by overpaying their mortgage by £200 a month, paying off their mortgage three years and eight months early.

But, if that £200 were to be saved in a savings account over this time instead (assuming the interest stayed the same), they’d earn £42,670 in savings interest – nearly £26,000 more than the interest saving they’d make by overpaying.

“It could make sense to build up a savings fund that could then be used to reduce the mortgage when the current deal ends,” said Mr Hollingworth.

Should you invest instead?

If other debt, retirement pots and emergency savings are in a good place, you may find yourself weighing up the benefit of investing versus paying down mortgage debt.

You certainly don’t need to pay out huge amounts to do either: regular investing at £100 a month over five years with average returns of 4.5pc equates to £6,590 (investment growth of £592.20). If you achieve 7.5pc returns, the balance rises to £7,110 (investment growth of £1,105). Both of these examples assume charges of 0.75pc a year.

Alternatively, using that same £100 a month to overpay a mortgage could still save you thousands. Taking the typical five-year fixed rate of 5.18pc (as of January 30, according to Moneyfacts) on a £300,000 mortgage (25-year term) would save a total of £27,366 in interest over the life of the mortgage and reduce your loan term by two years and six months.

On paper, it makes sense to invest your cash if you think you’re going to make a return that’s going to be higher than the interest you’re paying on your mortgage.

And while the average fund whose remit is to invest up to 60pc of its money in stocks has returned 7.6pc over the past five years, according to AJ Bell, you may not have the appetite for stock market uncertainty.

An exception to this: young homeowners may be better off investing extra cash via a pension rather than overpaying their mortgage, according to research from Interactive Investor.

There’s no definitive “right” answer here. What you ultimately opt for may not be the bigger financial gain according to a spreadsheet or our calculator, but if it gives you the peace of mind you’re looking for then it could still be worth doing.

This article was first published on December 14, 2023 and is kept updated with the latest information