Martin Lewis has shared two key checks to make before overpaying your mortgage, as the Bank of England is predicted to raise the base rate from 3.75% to 4% in November.
After more than two years of drops followed by recent stagnation, many are predicting the increase. 'In fact, the market is currently pricing in that the rate will rise four times over the next year,' Martin Lewis writes in his latest newsletter. 'As new fixed mortgage rates depend on the market's view of future rates, fixes are getting costlier… Plus, tracker and variable rates are likely to follow suit.'
What to consider before overpaying
According to the Money Saving Expert (MSE) founder, this hasn't gone unnoticed by his readers — particularly homeowners keen to make the most of their money. Ahead of any potential hikes, Martin says one of the most common questions this group are asking him right now is whether they should save or overpay their mortgages.
While everybody's situation is different, and only you can decide what's best for you, these MSE 'need-to-knows' can help you make an informed choice based on your unique circumstances. First off, look at where your money would work hardest. If you have more expensive card, loan or overdraft debt, Martin says 'it's generally best to prioritise using spare cash to clear them instead', whereas if your mortgage rate is higher than the (after-tax) interest on savings, 'overpaying adds up.'
How much could overpaying save you?
In reality, this all depends on your specific rate, amount and repayment term. However, MSE ran the numbers using a hypothetical £200,000 repayment mortgage at 5.5% with a 20-year term, and the savings are pretty huge.
- A one-off £5,000 overpayment: £9,600 interest saved, mortgage cleared 10 months earlier
- £100 a month overpayment: £16,950 interest saved, mortgage cleared two years and three months earlier
- A one-off £5,000 and £250 a month overpayment: £41,450 interest saved, mortgage cleared five years and five months earlier
For many, overpaying may seem like the right choice. But before you ring the bank to up your direct debit, Martin urges you to make these two key checks:
Two key checks to make
Are there overpayment penalties? Although lenders typically let you overpay a certain proportion (usually up to 10%) of your mortgage balance each year without a penalty, this isn't always the case. Even if your provider does offer an early repayment allowance, going above their set amount will likely accrue 'penalties which could wipe out much of the gain'. Often, these fees sit around the 1% to 5% range, so it's important to look at your contract to work out what's what.
Do I have a cash emergency fund? 'The fact you've overpaid your mortgage doesn't automatically mean if circumstances change and you suddenly can't repay, the lender will say "oh, no probs" — you'd still be in arrears,' says Martin. His rule of thumb for rainy day prep is saving enough to cover three months of bills (although six months is 'even better') in an accessible account. The podcast host says that unless you have a specific offset mortgage, you should 'only overpay with any money above that.'
What to do after overpaying
From there, if you've done the sums and still think overpaying is the best course of action, Martin recommends making sure you tell the lender you want it to reduce the capital owed, not the monthly repayment. 'This way you'll be mortgage-free quicker,' he adds. But if they're making it difficult, only agreeing to lower your monthly repayments, 'just keep paying what you were or more (effectively overpaying each month) to have the same impact.'
If saving beats overpaying your mortgage... 'There are still many people with super-cheap 1% or 2% mortgages, who right now are far better off saving than overpaying,' says Martin. 'For many others, it's a closer call. Yet both should be aware that at some point, that deal will end and your new mortgage rate could be far higher, meaning the equation changes.' Either way, if you decide it's better to save, he recommends ensuring the money you've put away is available when your deal is coming up for renewal, as that way you can use it to reduce your borrowing if required.
