When you take out a mortgage, a number of factors go into working out what your monthly repayment will be. The size of the loan and the interest rate are big ones of course, but the term of the mortgage - how long you have in which to pay it off - will play a big part too.
So for example, if you opt for a 25-year term, the lender will calculate what your monthly repayment needs to be in order to clear the balance in exactly 25 years.
However, some mortgages allow you to opt to pay slightly more than this set monthly repayment. And if you can afford to do so, it could leave you far better off.
The borrowers most likely to overpay
Earlier this month, consumer champion Which? Published its own research into which borrowers across the country are the most likely to pay a little more than they have to on their mortgage bills.
It found that borrowers in London and the West Midlands were most likely to opt to overpay, with 60% of mortgage customers in the capital opting to pay more than they have to each month followed by 52% of those in the West Midlands.
In contrast, it’s borrowers in Scotland who are least likely to see the benefits of overpaying, with a paltry 38% doing so.
There is also a significant generational divide when it comes to overpayments. Which? Found that more than two-thirds (69%) of borrowers aged 18-24 are opting to overpay, compared to 45% of 35-44 year olds and 38% of borrowers aged between 45 and 50.
How do overpayments work?
Many mortgages will punish you if you want to pay them off early, whether in part or in full, in the form of an early repayment charge. This is a fee that is calculated as a percentage of your outstanding balance, so it can easily run into the thousands.
For example, if you have a five-year fixed rate mortgage, then it’s not uncommon for the early repayment charge to be 5% in the first year, 4% in the second year, and so on until the end of the fixed rate period.
However, most mortgages will allow you to overpay on your repayments by up to 10% of your outstanding balance, without facing this charge. You can do this on a monthly basis, so simply increase the size of your direct debit payment, or you can do it in a lump sum, perhaps because you enjoy a regular, annual bonus.
What difference does overpaying make?
It’s easy to appreciate the potential benefits of overpaying when you take an actual example.
Let’s say that you have a £150,000 mortgage, on a 25-year term, and you currently pay a mortgage interest rate of 2.5%. Your repayments should be something like £673 a month, meaning that it will cost you a total of almost £202,000 in order to clear that loan.
But let’s say you can spare an extra £50 to go towards the mortgage debt each month so opt to increase your payments to £723 instead.
Doing so would mean that the mortgage is paid off entirely two years and three months earlier than scheduled. What’s more, the total cost of doing so would be £196,671, meaning you’d save almost £5,000 in interest payments to boot.
Should I overpay?
Ultimately the decision over whether overpayments are a good idea for you will come down to your individual circumstances.
There is no point ratcheting up your monthly mortgage bill if that then leads to difficulties meeting your other financial commitments. Similarly, if you don’t have some money in savings that you could call on in an emergency, then that should really be your first priority with any spare cash you have each month.
But if you can afford it, paying a little extra now in order to save thousands in the future is undoubtedly a smart move.