When you take out a mortgage, it typically lasts for 25 years, but you can take years off the term of the mortgage by making extra payments. Paying off your mortgage early also means you’ll save on interest.
Why think about paying off your mortgage early – what’s the benefit?
How would you feel if you didn’t have to make your mortgage payments every month? What would you be able to do if you didn’t have to earn enough to pay your mortgage? For most of us, our mortgage will be the biggest debt we ever take on. While owning your own home may be something you aspire to, paying the mortgage month in, month out, probably isn’t.
Most mortgages are set up to be repaid over 25 years, but it doesn’t have to be that way. Interest rates are at a record low, and mortgage rates – for many homeowners – are at record lows as well. I appreciate that paying extra on your mortgage may not be an option for everyone, but if you have money to spare, I’d recommend you think about it.
Paying off your mortgage early – where to start
There are two ways to go about paying off your mortgage early:
- Pay what you can afford every month.
- Work out when you’d like to be mortgage free and how much extra you’d need to pay, and pay it.
SAVVY TIP: Most of us save more if we have a target, so the second method could mean you’re mortgage free sooner. But paying a little extra every month is better than doing nothing.
Warning: Don’t overpay on your mortgage if you owe money on expensive debt, such as a credit card, store card or personal loan. If that’s the case you’re better off paying off these debts as quickly as you can.
Paying off your mortgage early – how much can you save?
You can make big savings; for example, if you overpaid by £200 a month on a £200,000 mortgage charging 5% interest, you could take six years and three months off the term and you’d save over £40,000 in interest. If your mortgage was charging interest at 3%, you’d save £21,000 in interest and you’d take five years and 11 months off the term.
Use a mortgage overpayment calculator to work out how much you can save. Most mortgage brokers have them. There’s one on SavvyWoman’s Tools and Calculators page.
To give you an idea of how much you could save on a £200,000 repayment mortgage running for 25 years, charging 3% interest:
- A £10,000 lump sum: paid off in year one would knock almost two years off the mortgage term.
- A £10,000 lump sum: paid off in year ten would knock one year and five months off the mortgage term.
- An extra £100 a month: would knock over three and five months years off the mortgage term.
- An extra £50 a month: would knock one year and ten months off the mortgage term.
SAVVY TIP: Your bank or building society will calculate your new mortgage term when you make overpayments, but I’d double check them using an overpayment calculator.
Paying off your mortgage early – where do you start?
Most mortgage products will let you make some overpayments, but there are likely to be upper limits on how much you can overpay in any one year. Some lenders (particularly the smaller building societies) may set a lower limit as well.
So, how do you do it and what do you need to know?
1. The amount you can overpay each month or year varies from lender to lender. The upper limit may be a percentage of your loan. Typically, many lenders will set this limit at 10% of your monthly payment or of your mortgage. You are more likely to have a limit if you are on a fixed or tracker rate mortgage that has a penalty for you paying it off early.
SAVVY TIP: If you pay off more than the bank or building society’s limits, you will be charged the early repayment penalty, which could be substantial (on some fixed rate mortgages it can be 5% of the amount you borrow, in the early years of the deal).
2. The upper limit may be a fixed amount. Some lenders will set a fixed sum of, for example, £500 a month. Although the limit is quite generous (depending on the size of your mortgage), it could limit your overpayments if you have a large mortgage you want to clear quickly.
3. Standard variable rate mortgages may not have an overpayment limit. If you’re not on the standard variable rate, you may be able to pay off as much as you want, when you want. However, this varies between lenders.
4. Flexible and offset mortgages let you pay off your mortgage with little or no restrictions. These mortgages are designed to let you make extra payments.
SAVVY TIP: You can read more about how offset mortgages work in my article Could an offset mortgage save you money?.
How can you overpay your mortgage?
Many banks and building societies are fairly flexible about taking overpayments. You can generally:
- Set up a standing order for the overpayment amount. Useful if you want to make regular monthly payments and you can easily stop and restart the standing order.
- Pay by internet or telephone banking. For one-off payments or payments of varying amounts.
- Pay by cheque. Also for one-off payments.
- Pay by direct debit: Some lenders will increase your existing mortgage direct debit payment, rather than setting up a separate standing order. The disadvantage is that you’re reliant on the lender changing it back again if you want to stop the overpayments.
SAVVY TIP: Make sure you talk to the bank or building society first and tell them you want to make overpayments. This applies if you’re making a one-off payment by cheque or online banking or setting up a standing order or getting the bank to increase your direct debit payment.
Making sure the payment reduces your mortgage debt
These days, most mortgage lenders calculate interest on a daily basis. What that means in English is that they immediately deduct any payments you make from the amount you owe on your mortgage. So, if you make a mortgage overpayment, it should be credited straight away (usually by the next day) and should reduce your term and the amount of interest you owe.
SAVVY TIP: If you have a very old mortgage product, especially if it’s with one of the smaller building societies, there is a slight chance that the amount you owe is adjusted less frequently. Make sure you get details in writing from them about how extra mortgage payments will be credited to your account.
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