Making the most of mortgage overpayments

Published 07th Sep 2009

British households are, for the first time, repaying more debt than they're taking out. Should you join them and pay off your mortgage early? Rupert Jones reports


Shock news: Brits are repaying their debts. For years we were Europe's most credit-happy consumers, unable to resist the lure of super-sized mortgages and seemingly addicted to flexing our plastic – but now it looks as if we have caught the thrift bug.

Bank of England data issued this week shows that, for the first time since records began in 1993, homeowners are paying back more on their mortgages than homebuyers are borrowing.

The figures reveal that last month, the nation's mortgage-holders paid back £418m more than was lent out in home loans. And there was a chunky reduction in unsecured debt, indicating many people are paying off loans and overdrafts, and shunning new credit. Of course, this partly reflects the ongoing financial squeeze, which has made it harder to obtain affordable credit. But much of it is down to borrowers using a period of ultra-low interest rates to pay down debts.

There has been plenty of research showing there has been a surge in the number of people making overpayments on their mortgages. If you are one of the lucky souls who is saving hundreds of pounds a month after seeing your monthly payments fall sharply, it really makes sense to use at least some of this cash to take a bite out of your biggest debt.

But what are the best ways to do this – and are there any pitfalls?

Low savings rates are one obvious reason why paying more than you need to, can make financial sense. However, the best thing about overpaying is that it can save you thousands of pounds in interest, and lop years off your mortgage. Nationwide calculates that someone overpaying by £75 a month on a 25-year, £80,000 repayment mortgage at its standard rate (currently 3.99%), could save more than £11,800 and pay off the loan five years and nine months early.

Overpaying should also reduce your loan-to-value (LTV) ratio. Some people overpay because they hope that, by increasing the amount of equity in their home, they will have access to more attractive home loan deals when they come to remortgage.

But it doesn't always make sense. If you have some spare money, pay off your most expensive plastic first. If you're lucky enough not to have any credit card debt, or other expensive borrowings, then making mortgage overpayments is definitely a good idea – provided your home loan rate is higher than about 2%, says Ray Boulger at broker firm John Charcol.

If you are on a super-low rate – such as one of those trackers where you are paying next to nothing – then he reckons it makes no sense to pay debt off early. "You are just making a free gift to your lender."

Instead, put the money into an instant access savings account or a mini cash Isa paying a decent rate. You will be building up a lump sum which you can then throw at your mortgage when the rate eventually increases.

Nowadays, many mortgage deals will typically allow borrowers to overpay up to 10% of their home loan each year without penalty.

Some flexible deals let people overpay by as much as they like, but there are other products and lenders that have much stricter rules, so don't do anything until you have checked the small print.

"As a starting point, look at what your overpayment charges are. Make sure you don't overpay more than you're allowed to," says Boulger.

For example, a number of building societies only allow you to overpay by a certain amount each month. If you are on a Nationwide fixed-rate or tracker deal, you may not be aware you can only overpay up to £500 a month without incurring a penalty. If you go over that, you'll be hit with an early repayment charge on the entire overpayment. These range from 2% to 5%. That could mean a £50 on a £1,000 overpayment.

Of course, only a small minority of borrowers are going to be in a position to be able to afford that level of payment, though the huge savings some people have enjoyed on their tracker loans have increased their numbers.

A Nationwide spokeswoman says: "Anecdotal evidence suggests £500 is a limit that works for our customers ... We believe this is in line with the rest of the industry."

Similarly, Britannia building society only allows people to overpay up to £499.99 a month with no charge.

It's important to check when your lender will deduct any money you overpay from your balance. Hopefully, the answer you will get is: the same day or the next working day.

In some cases you may have to wait a while. Alliance & Leicester allows borrowers to pay off up to 10% of the mortgage a year without penalty, subject to a minimum of £500, but the overpayments have to be made in January. So if it is February, you might as well stash the cash in a savings account where it can earn interest until the start of the following year.

If you have got a flexible mortgage, look at your deal's small print to check whether you have an automatic right to borrow back any money you have overpaid. In June, Guardian Money told how Abbey had been accused of whipping away money that some flexible mortgage holders had paid into their accounts, and which they were perhaps hoping to dip into later. This was linked to the fact the bank had reduced the estimated values of their properties.

Some home loans offer an "offset" facility, where you use your savings cash to reduce the amount of interest. If you have got one of these deals, Boulger says any overpayments you are in a position to make should always be paid into the linked savings or current account rather than into the mortgage.

Many people will have more traditional mortgages where, once you have made an overpayment, you cannot get the money back. So think carefully before making a move.

In the current difficult economic climate, it is important to have some cash set aside for emergencies etc. As a rough rule of thumb, everyone should have a savings pot worth at least three months' salary to meet "rainy day" needs – such as losing your job.

And if you are likely to need some money to buy a car or new kitchen in the near-ish future, because it is now a much tougher environment for borrowing, you might be best advised to hang on to your spare cash in a decent savings account.

• There was some good news this week for people looking for a mortgage, with a flurry of home loan price cuts. But the best deals are still being reserved for those with large deposits.

HSBC has launched what it says is its cheapest-ever mortgage – a two-year discount deal with a starting rate of 1.99%, available only to borrowers with at least 40% to put down as a deposit. Those with 25% equity are offered a rate of 2.49%, while for those with a 10% deposit the rate is 3.89%. The deals also have a sizeable arrangement fee of £1,199.

Meanwhile, the Woolwich has cut the price of its two-year fix by 0.2% to 4.09% with a fee of £999. It also launched a second loan with a £499 fee and a 4.19% rate. Both are restricted to 70% loan-to-value. Cheltenham & Gloucester has made similar cuts.

Source: ' Guardian '

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