Overpaying on the mortgage

[buttery81]

DH and I are considering whether to make an overpayment once a year on our mortgage. At the moment we have 25 years left on the mortgage, but overpaying by something like £3k per year could apparently reduce the term by almost five years.

I'm just a bit confused as to whether I should be asking the bank to reduce my monthly payments or shorten the term. If the latter, does that mean my monthly payments will go up or will they stay the same? We're on a five-year fixed deal at the moment.

Also, do all banks offer the option of shortening the term or do some only allow you to reduce the monthly payments (without shortening the term)? I can't find anything in my T&Cs on this - it just states that when the bank receives an overpayment they will recalculate the amount we owe and the interest we will pay.

I'm amazed by how £3k a year can cut so many years off the mortgage - I can't quite believe it, but that's what the Money Saving Expert calculator seems to suggest. Does that sound about right?

If you are on a fixed term mortgage, the bank will have taken out a swap that means that whatever you pay translates into an amount to pay the floating rate at the moment. If you overpay, they may not be able to use that amount t against the mortgage as they are in a fixed term derivative contract for your mortgage.

You need to check your T&C and speak to them to explain when the overpayment would actually be credited to your mortgage account.

Say you owe £120 at £10 a month. Then you make an overpayment of £20. You then owe £8.33 a month for 12 months or £10 a month for 10 months. That's why your payments don't increase, but you can use overpayments to decrease them.

If you make an overpayment and then drop your payments you aren’t overpaying.

Well surely that depends on the amount of overpayment relative to the monthly mortgage payments and the size of the mortgage.

When I started my overpayments the building soc asked me whether I wanted to reduce or maintain the payments (I was making monthly overpayments though, not annual ones).

And it’s a good point to look into whether you can get a better rate by putting the money into an account that pays higher interest than your mortgage rate.

Usually you don't need to ask them to change the term. You just make the extra payment and ask to keep your monthly payment the same. You just get to 0 before the end of the expected term. That way if your circumstances change you can go back to the lower level of payments to finish at the expected time. Check with your lender to ensure you understand the ts & cs though.

It will depend on your T&C when they recalculate. Don't change your term, they will likely charge you to do that.

Our last mortgage we overpaid but we just changed the monthly DD to do it. We weren't on a deal at that point so repayments were recalculated immediately we made an overpayment so we got a letter each month telling us our monthly payments had gone down. So say we'd been paying ~£500pcm, we changed DD to £1000pcm so overpayment of £500 initially. But after a while the statements said it was a payment of £400pcm month and an overpayment of £600pcm and that ratio kept moving.

Our current mortgage is a fixed deal so doesn't recalculate the monthly payments with each overpayment but at the end of the fixed term it will. As others say, there will limely be a maximum overpayment you can make each year of the fixed term.

My last mortgage in the UK wouldn’t allow overpayments at all, so check with your bank.

I love my mortgage here in the US - it’s 30 years fixed at a low rate, and we can overpay at any time, by any amount. There have been months I’ve only been able to overpay by $50, and other months where I’ve made double or more of a payment, and all the extra goes to the capital and reduces the interest. So far I think we’re on track to pay it off five years early, but I’m hoping to be much sooner than that.

We overpay monthly by SO. Get a letter each month saying it's been applied to reduce the term. We've had this mortgage 2 years and have knocked an extra year off the term already.

Monthly is better than annually because it affects the balance and therefore the interest straight away.

I could have opted to reduce payments but we want to get rid of our 25 (now 22) year mortgage quicker if we can.

Thanks for the advice everyone. For me it makes more sense to make one large annual repayment rather than overpay monthly, as my bank charges an admin fee for any overpayments that are under £500 I believe. I can pay up to 10% of the total mortgage each year without penalty (not an issue as there’s no way I could afford to pay that much anyway!) I will investigate savings accounts first though and see if I can find one that pays out more interest than my mortgage rate. Thanks again for the tips!

If you can overpay then do so. Interest rates may go up the future but they'll never get lower. If you extend the term and interest rates go up you would have to find even more. Overpaying each year gives you more flexibility, and means you may have paid off your mortgage at a time when interest rates are far higher than they are now.

Makes me realise how lucky I was with my last mortgage. No limit on overpayments and they could be drawn down if I wanted. I was overpaying by £1k a month in the end and had it paid off before I was 39. Mind you, the interest rate was slightly higher than what I’m reading here.

beachyhead
I am surprised that the mortgage provider would micro hedge on a loan by loan basis. I would have expected more dynamic macro hedging across the portfolio especially if they are bundling up the loans for RMBS.

Personally Id always opt for reducing monthly payments BUT keep paying the same within the allowed overpayment amount ( usually 10%)
This still reduces how much you owe faster but should anything happen in the future financially, you can reduce your payments to the minimum if necessary
Im always overpaying like this x

If you increase the standard DD, just be sure you can maintain that ongoing, because if you get into financial difficulty, that is the sum the lender will expect from you. Or you'll need to negotiate a lower payment again, which can potentially cause complications/issues with credit rating etc.

However if you make voluntary payments separately, you can stop and start them at will with no impact on anything.

Also be aware that most mortgages the 10% is the outstanding balance as of the anniversary.

Example (all figs very approx):
Year one - £150,000 mortgage balance
12 x standard £600-ish repayments
PLUS 10% £15,000 overpayments.

Year two - ~ £125,000 mortgage balance
12 x standard £600-ish repayments
PLUS £12,500 overpayments

And so on.

Secondly, check whether your interest is calculated daily, monthly or annually and pay accordingly to minimise.

If you Google loan amortisation and find a spreadsheet, you can see with your own eyes how beneficial it is to overpay. The monthly amount will remain the same. It's just that more of the payment will be going directly towards reducing the principal amount (what you owe to the bank). At the start if your loan, each month you pay a shed load of interest but the gap closes until finally one day half way through the life of the loan you'll start paying marginally less interest than principal. When you're in the final years of your mortgage then most of your payment will be for the principal and a small amount will be the interest.

Check that your mortgage allows up to 10% overpayments (usually does).

Then you DO NOT need to change mortgage term etc. You just transfer more money - either lump sums as and when or change your DD to include the overpayment on a monthly basis.

That's 10% annually of the outstanding balance (e.g. 20k a year if you have a 200k mortgage).

If you increase the standard DD, just be sure you can maintain that ongoing, because if you get into financial difficulty, that is the sum the lender will expect from you. Or you'll need to negotiate a lower payment again, which can potentially cause complications/issues with credit rating etc.

However if you make voluntary payments separately, you can stop and start them at will with no impact on anything.

Ah that's very good to know, thanks. I can't be sure that I'll be in this financial position long-term, so will definitely avoid increasing the direct debit!

Then you DO NOT need to change mortgage term etc. You just transfer more money - either lump sums as and when

Brilliant, thank you!

I don't reduce the term just overpay what I can. You never know what's round the corner so I can hold back the overpayments if needed.

@LoubyLou1234 does that mean your term will naturally come to an end earlier than the original date anyway, because you're making the overpayments?

Speak to a mortgage broker to make sure it makes sense for you.

FYI to reduce the term it is an application process and you’ll need to go through affordability checks to ensure it’s responsible for the bank to change the term and payments. You can’t just phone them and amend. It’s a contractual change to your mortgage therefore they have to meet regulations.

Sorry to double post but also make sure any overpayments are within your overpayment allowance as per your original mortgage offer.

Usually you don't need to ask them to change the term. You just make the extra payment and ask to keep your monthly payment the same. You just get to 0 before the end of the expected term. That way if your circumstances change you can go back to the lower level of payments to finish at the expected time. Check with your lender to ensure you understand the ts & cs though.

Missed this - thanks @countrygirl99, that's what I was hoping.

I'm glad I posted on Mumsnet first, as initially I thought I had to ask the bank to decrease the term!!

Thanks Xyz - yes, I've realised (thanks to Mumsnet!) that I definitely don't want to officially reduce the term. I just want to make overpayments so the amount I owe gets to £0 quicker!

FYI to reduce the term it is an application process and you’ll need to go through affordability checks to ensure it’s responsible for the bank to change the term and payments. You can’t just phone them and amend. It’s a contractual change to your mortgage therefore they have to meet regulations.

No it isn't. Or at least it's a case by case basis.
Your mortgage may require that but the ones I've had simply offer me the choice to reduce monthly payments or reduce term. Job done.