Mortgage method could 'shave years off' with 'small payments'

Mortgage brokers say that far too few borrowers capitalise on the opportunity to make overpayments on their mortgage, which can substantially diminish the long-term cost of what is most people's largest debt. One broker described the overpayment as an "underused strategy", while a lender remarked that "even modest overpayments can save an owner thousands over the life of the mortgage" - though brokers and lenders alike emphasise that overpayments may not suit everyone's circumstances.

Lenders generally permit borrowers to overpay up to 10% of their mortgage balance annually, though in certain instances it can reach as high as 20%. When individuals make overpayments, most lenders will offer them the option of having reduced monthly repayments going forward, or shortening the mortgage term.

However, while making overpayments can deliver financial advantages for numerous borrowers, Asis Tewari, Co-founder at smart mortgage app, nume, said "the problem is that almost no one is helping them think about it properly".

Jamie Elvin, director at Strive Mortgages, said: "Making mortgage overpayments can be one of the simplest ways to reduce the total interest you pay over the life of your mortgage and, in many cases, shave years off the term. Even relatively small, regular overpayments can make a meaningful difference over time.

"That said, borrowers should first check whether their lender applies any early repayment charges and ensure they have a healthy emergency fund before committing extra money to their mortgage. Overpaying isn't always the right choice if you're carrying more expensive debt or may need access to those funds in the near future."

Ben Perks, managing director of Stourbridge-based Orchard Financial Advisers, described the mortgage overpayment as "an underused strategy".

He went on to say: "Overpayments kick the backside out of mortgages, potentially knocking years off the mortgage term and saving borrowers thousands in interest."

The difficulty, according to Tracey Dixon, owner of Cardiff-based Pure Mortgage and Protection, frequently comes down to a lack of understanding as to how overpayments can be made and the level they can be.

She continued: "Many borrowers don't realise that overpaying doesn't have to mean paying hundreds of pounds extra each month. Even a small regular overpayment can reduce the overall interest paid and, in many cases, shorten the mortgage term.

"That said, overpayments aren't suitable for everyone. Before making them, borrowers should check that their mortgage allows penalty-free overpayments and ensure they have an emergency fund in place.

"While many lenders permit overpayments of up to 10% of the outstanding balance each year, the rules can vary between products. I always discuss overpayments with my clients because, where they're affordable, they're one of the simplest ways to reduce the long-term cost of a mortgage.

"The industry as a whole should do more to generate greater awareness of overpayments. Many people are surprised by the impact that even an additional £50 per month can make over the life of their mortgage. Even small regular payments can have a big impact if you keep them up."

Ross Lacey, director of Rayleigh-based Fairview Financial Management, agreed that overpayments were not suitable for everyone.

He said: "For some people, it can make sense, but there are definitely situations where it doesn't. We have clients who still benefit from mortgage rates starting with a 'one'. For them, the money that they could overpay is often better placed sitting in a savings account earning three or four times that.

"We also have other clients, who have money in savings accounts earning 4.5%. They are higher rate tax payers so only really get about 2.5% in their pocket after tax. If they're paying 4.5% on their mortgage then this makes overpaying the mortgage a slam dunk victory.

"As ever, though, each situation is different, and keeping a certain amount in liquid cash is important. It's not as easy as some people may think to pull money back out after overpaying a mortgage. This is why we're seeing an increased interest in offset mortgages."

Martin Rayner, financial adviser at Compton Financial Services, said that, in his experience, most borrowers were not making regular mortgage overpayments.

He added: "The bigger question, though, is whether overpaying is the best use of your spare money. I do not automatically recommend it.

"We compare it against pensions and other investments first. Paying down a 4% mortgage gives you a guaranteed 4% return, but many higher earners can achieve a much better outcome through pension contributions. A higher-rate taxpayer can receive 66% effective tax relief, while someone caught in the £100,000 to £125,140 personal allowance trap can receive effective relief of up to 150%.

"Put simply, £40 of take-home pay can become £100 in a pension. Mortgage overpayments are a fantastic tool in the right circumstances, but they should be weighed against pensions, ISAs and other financial priorities rather than being treated as the default home for every spare pound."

Peter Dockar, chief commercial officer at lender Gen H, said: "Our own data shows around 6%–7% of Gen H accounts make an overpayment in any given month, which is in keeping with the industry average. This includes recurring overpayments of smaller amounts of a couple of hundred pounds per month and one-time lump sums from owner inheritances or gifts, which are typically £100,000+.

"Though even modest overpayments can save an owner thousands over the life of the mortgage, deciding to overpay isn't always an obvious choice. Overpayments are a guaranteed, tax-free return equal to the mortgage rate, and they reduce the loan-to-value (LTV) faster, which can secure much cheaper rates at remortgage.

"But borrowers may be able to earn more with high-return savings accounts or by investing in their pensions, so it's not necessarily an appropriate tool for everyone. This is where advisers play an integral role in helping owners plan how to use their money today to build a secure, comfortable tomorrow."

Richard Davidson, mortgage advisor at onlinemortgageadvisor.co.uk, said: "From what we see, only a small minority of borrowers overpay regularly, but that share climbs noticeably as people get within sight of the end of their term and the finish line comes into view. Plenty like the principle of overpaying, yet actually managing your mortgage month to month is easier said than done, and that is where most of the opportunity quietly gets missed.

"Small, regular overpayments really do add up and can take years off a term, so yes, I encourage clients to look at them. The honest caveat is that overpaying always has to be weighed against the opportunity cost of saving or investing instead and with savings rates where they have been over recent years, some people are genuinely better off keeping that money elsewhere. The education people actually need is about making that choice for themselves rather than simply being told to overpay."

Scott Taylor-Barr, principal adviser at Leicester-based Barnsdale Financial Management, said "many people mistakenly think that overpayments have to be lump sums, so are surprised when I tell them that most lenders will allow them to amend their monthly direct debit".

He added: "So rather than pay your lender £856.89 per month, just ask them to increase that to £860, or £900, as even those quite modest overpayments will make a difference to your mortgage term and, ultimately, the total amount of interest you pay. The vast majority of lenders charge interest daily, so by making regular overpayments is more effective than saving up and then paying the same amount as a lump sum."