Maximising savings is something everyone should try to do - and what better way to save money than by overpaying your mortgage?

The truth is that overpaying your mortgage is a decision you shouldn’t take lightly. Where personal finances are concerned, there are lots of moving parts to consider.

Read on to find out more about overpaying mortgages. Is overpaying truly worth it and should you do it?

Is it worth overpaying my mortgage?

By overpaying your mortgage, you reduce the time it takes to pay off your mortgage - and the feeling of security that a loan-free property provides is incomparable. Whether this is choice you consider worth your time and effort is another story.

Some homeowners may wish to invest in other savings options - opening a new account with better interest rates, or investing in a stocks and shares portfolio.

The choice is entirely yours. To help you decide, we’ve taken a closer look at some of the advantages and disadvantages of overpaying on your mortgage.

Advantages of overpaying your mortgage

1. Reduce the size of your mortgage interest-free

Most mortgages come with a fixed rate of interest. That is, the loan you originally took out will earn interest (a percentage of the outstanding amount) each year.

When you overpay your mortgage, you pay over the set amount agreed in a monthly mortgage repayment. You are paying beyond the rate of interest.

In other words, an overpayment reduces the size of your mortgage without the extra interest added on. Effectively, you pay your mortgage back quicker.

2. Access a better mortgage deal

By overpaying your mortgage, you gain access to better deals when you remortgage.

As you reduce the size of your mortgage, your Loan to Value (LTV) also reduces because it represents how much of the property your mortgage provider owns.

While your LTV is useful for working out how much of the loan is left to pay, it’s also what lenders use to determine the number of deals made available to you.

For example, if a lender offers you a mortgage of £90,000 for a house worth £100,000, you’ll pay a 10% deposit to cover the outstanding amount - this will make your LTV 90%.

A high LTV like 90% indicates that you are yet to pay back the bulk of your debt and that the lender still owns most of your property. As a result, lenders are less likely to offer good deals to people with high LTVs.

On the other hand, low LTVs such as 40% or 50% suggest that you are nearing the end of your agreement because you have built greater equity in your home. As a result, lenders will be willing to lend you more money with better interest rates and payment plans.

If you're selling your home and upgrading to a larger property, you can use your low LTV to your advantage when you remortgage! Access to more money with friendlier repayment plans will make your move much more bearable.

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3. Potential for greater returns than savings

If you have savings, you might be better off using them to overpay your mortgage. While some savings accounts can offer acceptable interest rates, they are often extremely poor.

With a mortgage overpayment, you make the same gain as saving at your current mortgage rate. Indeed, the amount you can save by overpaying is likely much higher than potential returns from savings.

If you kept £20,000 in a 3.5% savings account, you would earn just £700 a year. But if you overpaid a typical mortgage with only half this amount (£10,000) you could stand to make a big return.

Take a 25 year mortgage of £120,000 with an interest rate of 3.5%. A one-off payment of £10,000 (as of Sep 2022) could save you nearly £13,000 in interest and help you pay off your mortgage three years earlier.

To find out how much interest you can save, use an online mortgage overpayment calculator. There are plenty of options just a click away!

Disadvantages of overpaying your mortgage

1. Not all mortgages allow you to overpay

Some lenders do not allow you to overpay your mortgage. Check your mortgage contract or ring your lender to make absolutely sure you are able to.

2. Overpaying too much could lead to charges

Most lenders allow you to overpay your mortgage by around 10% a year, If you exceed this amount, you could be liable for charges.

These types of charges are called Early Repayment Charges (ERC) and they are usually 1-5% of the outstanding loan. While paying any type of fee for an overpayment is not ideal, sometimes it can be worth it.

If you only have £20,000 of your initial loan left to pay, paying a 5% charge (£1000) to reduce your outstanding amount by £10,000 could be a worthwhile price to pay. But if you have £200,000 left on your mortgage, a charge as low as 1% could leave you with an ERC of £2000.

Exceeding your yearly repayment limit may only be worth it when your outstanding loan and interest are smaller.

3. You could use the money elsewhere

To make a sizable dent in your mortgage, you’d need to make a substantial overpayment or regular little ones. Whilst the impact made by one is slightly more substantial than the other, they both serve the same purpose - to reduce your overall loan and accrued interest.

But overpaying relies on you having a bit of extra cash lying around. If you don’t have the extra money to spend, you might be better off building an emergency savings fund first.

An emergency fund ideally consists of 3 to 6 months worth of cash for rent, bills and food. If you lose your job or need to make a maintenance payment, a fund like this can come in handy.

Before you start saving for an emergency fund or overpayments however, you must clear all other debts on credit cards and loans. These have higher interest rates than mortgages, so it makes sense to clear them before you start worrying about any other types of savings.

How does overpaying your mortgage work?

Overpaying your mortgage is when you exceed your pre-determined monthly repayment figure. By paying more than the agreed amount, you reduce the size of your overall loan through interest-free payments.

With regular monthly payments or a single lump sum (along with your usual mortgage repayments), you can repay your mortgage debt faster and live mortgage-free several years early.

How do I overpay my mortgage?

If you’re overpaying your mortgage for the first time, we recommend simply ringing your lender to let them know your intentions. You’ll need to check:

1. Whether you can actually overpay your mortgage with them
2. What the yearly overpayment limit is
3. How the overpayment will be processed

Number three is quite crucial. Your overpayment can be processed in one of two ways:

• Used as a contribution towards next month’s mortgage repayment
• Used to reduce the total mortgage term

You should always choose to reduce the total term of the mortgage. If you choose to pay as a contribution towards next month’s mortgage repayment, you won’t get the bonus of reducing the actual term of your mortgage and saving a solid chunk of interest.

Remember: Brokers are not to be confused with mortgage providers. A broker is not a lender, so while they can advise you on the best mortgage package, your lender will have all the details on overpayments.

How much can I overpay on my mortgage?

Most lenders allow you to overpay your mortgage by 10% each year. Always check with your mortgage provider to find out the exact amount you can overpay by.

If you exceed your limit you may be liable for Early Repayment Charges, which can be 1 to 5% of the outstanding balance. This can be extremely expensive if you have a lot left to pay on your mortgage.

Is your house taking too long to sell?

Alternatives to overpaying your mortgage

Not keen on making overpayments? There are other ways you can save!

Add to your pension pot

If you have a pension pot, remember that you can always add your extra money to it - on top of what your employers put in. Cash injections will also take advantage of your pot's tax relief.

Open a stocks and shares ISA

A stocks and shares ISA can be a good way to accumulate wealth over a long period of time. If you want to try your luck, setting an account up is very easy to do.

Unfortunately, while many pre-made portfolios offer excellent security, no one knows what is round the corner. Events like the Covid 19 Pandemic can happen again and throw the world economy into disarray.

It's this type of unpredictability that can make saving with a stocks and shares ISA a little less reliable than overpaying your mortgage.

Remortgage to get a better deal

Remortgaging can help you get a better deal than your current mortgage agreement. Better deals might include improved interest rates or repayment options.

If you have a low LTV and you've reached the end of your fixed term, you should explore your remortgage options!

However, if you have a high LTV and haven't reached the end of your fixed term, regular mortgage overpayments might be the best option. You can bring down your LTV faster and get a few steps closer to remortgaging.

Can I make overpayments on an interest only mortgage?

Yes you can make overpayments on an interest only mortgage but you don't get the same benefits as overpaying on a repayment (capital and interest) mortgage. But how does this work?

When you overpay on a repayment mortgage, your additional payments (if set up correctly) will all go towards reducing your capital loan. With an interest only mortgage however, your overpayments only reduce future interest payments.

As a result, overpaying your interest only mortgage will not reduce your total capital loan or increase the equity you hold in the property.

Summary: Should I overpay my mortgage or save a different way?

To surmise: mortgage overpayments should only be an option for homeowners with an emergency fund and zero credit card or personal loan debts. If you are in a position to overpay your mortgage, make sure you can't make better savings first.

While there are plenty of other options for making capital growth than overpaying your mortgage, living in a property you own is undoubtedly a massive plus - some would even say it’s worth the loss of capital. By overpaying, your mortgage obligations will dramatically reduce, and you could upgrade your living space with much less hassle.