Has the thought of over-paying your mortgage ever occurred to you?
It could have massive implications for your future!
A small overpayment every month or year could result in saving thousands of pounds as well as taking years off the length of your mortgage. The chart below illustrates the effect of a small overpayment every month, over the course of your mortgage.
Effect of Overpayment
Overpaying £150 a month over a 25-year term on the above example could save you £15,910 in interest alone, and mean you pay the debt off in full 6 years and 2 months earlier.
What it means for your Loan to Value Ratio
Overpayments could knock years of your mortgage and save you thousands of pounds in interest rates, but you could save twice over, once you consider your Loan to Value Ratio (LTV).
Your Loan to Value ratio is the amount of money you borrow compared to the value of the property. If you bought a £250,000 and put down a deposit of £50,000 (20%) your LTV would be 80%.
80% of £250,000 = £200,000 (the amount borrowed)
As you pay off more each year your LTV will decrease as your equity stake increases. Your Loan to Value ratio will have a big impact on the rates you will be offered when you look to re-mortgage. These are normally triggered by meeting certain thresholds, typically 95%, 90%, 85% etc.
For example, there could be a big difference in the rates offered if you had 95% LTV ratio compared to a 70% LTV. If you elect to pay a higher amount off your mortgage each month you will reach these thresholds quicker and pay cheaper interest rates over a larger part of the mortgage term.
Speaking to your broker can help guide you as to how much to pay each month in order to reach these milestones in the most efficient manner.
Paying extra off your mortgage vs saving
There is a straightforward method to decide if you are better using your capital to pay extra off your mortgage or putting that cash in savings. Comparing the rate of interest you are receiving on your savings to the interest you are paying on your mortgage.
Before quantitative easing you could have reasonably assumed that you may be able to earn interest on your savings at a similar rate to that you pay on your mortgage, however current rates offered on savings accounts are pitiful and well below the rate of inflation meaning most people would benefit from even a small overpayment on their mortgage.
To demonstrate, if you are currently paying an interest rate of 3% on your mortgage and your savings account is paying you 1% then you could be better off overpaying your mortgage as it is costing you more in interest then you are earning on your savings.
£10,000 of mortgage debt at 3% interest will cost you £300 a year.
£10,000 of savings earning 1% interest will make you £100 a year.
In this case you would be £200 a year better off by making the overpayments rather than saving.
This is a basic sum and does not consider your tax rate so advice should always be sought to ensure you are making the best decision for your financial situation.
Check if you have any overpayment fees
Before you make the decision to overpay your mortgage you need to check the amount your lender will allow you to overpay by without being charged any overpayment fees.
Most lender will allow you to pay 10% off the balance of your mortgage every year free of charge if you are in your fixed rate or discount period. If you are outside of this period and have moved onto the Standard Variable Rate (SVR) then in most cases you can overpay as much as you like, although these do tend to be expensive and it would be worth talking to a broker to see if you could save more by re-mortgaging before you start overpayments.