When interest rates are low, it can sometimes be difficult to know what to do with all of your spare cash. According to Moneyfacts, as of 17 August, the highest return on an easy access savings account was just 1.67%, which is significantly lower than the rate of inflation.
Due to this, you might be left wondering how you can make your money work hard for you. If so, one option to consider is overpaying your mortgage.
While this can sometimes be a good idea, it isn’t always right for everyone, so read on to find out three of the most important pros and cons you should consider.
Pros
You can pay off your debt more quickly
One of the biggest advantages of overpaying your mortgage is that you can pay it off much faster than you would have otherwise. This can give you greater peace of mind to know that you won’t have the debt hanging over your head for as long.
When working out how much this can benefit you, the Nationwide overpayment calculator can be very useful.
Let’s say that you have £200,000 left on your 20-year repayment mortgage, with an interest rate of 3%. According to the calculator, if you increased your monthly payments by £100 then you would pay it off two years and two months sooner.
You can save money in interest payments
Another great reason to overpay is that, by settling your debt sooner, you could save a large amount of money in interest payments.
For the sake of simplicity, we’ll use the same mortgage as in the example above. According to the calculator, over the course of your term you would have to pay £66,207 in interest payments. This is a considerable amount of wealth, that you could otherwise be using to reach your goals.
On the other hand, if you overpay by £100 each month, then you would only have to pay £58,403 in interest payments. This means that you would save £7,804 over the course of the mortgage term.
You might save more in interest payments than you would earn from holding onto the cash
Realistically, a mortgage is likely to be one of the biggest financial commitments of your life and due to the large size of the debt, even small amounts of interest can add up quickly. That’s why you can save a large amount of money by paying it off sooner rather than later.
In fact, you can sometimes save more money in interest payments when overpaying than you would earn if you held the wealth in cash.
Cons
You may want to use your spare cash as an emergency fund
In the past few months, there has been a sharp increase in the cost of living. According to the Office for National Statistics, the rate of inflation rose by 10.1% in the year to July 2022.
These rises can make you more financially vulnerable, as when the cost of living is higher it can be harder to put aside wealth for the future. That’s why it can sometimes be useful to hold onto your spare cash and use it as an emergency fund rather than repaying it to your mortgage.
Having these reserves can help you overcome any unexpected problems that might affect your ability to keep up with mortgage payments in the future.
You may be able to save more money by paying off your other debts first
While overpaying your mortgage can save you money in the long term, you might be able to save more by settling other debts first.
For example, credit cards often charge high interest payments, as according to Moneyfacts, the average credit card charges an Annual Percentage Rate (APR) of 25%. At such a high level, the amount you owe can quickly grow into a huge sum.
That’s why, if you’re considering overpaying your mortgage, you may want to work out whether settling your other debts first might be more cost-effective.
You could incur a charge if you overpay by too much
Another important issues you need to consider is that some mortgages have an annual limit on how much you can overpay by. If you go over this threshold then you could incur a charge, which could erode any savings you would make by paying off your debt early.
This limit usually stands at around 10% of your remaining mortgage balance. For example, if you have £100,000 of debt remaining, then you’d be able to overpay by £10,000 each year without triggering a charge.
Of course, this limit tends to vary between providers, which is why you may want to check the terms and conditions of your contract. It’s also important to bear in mind that this usually only applies if you have a mortgage with a fixed, capped, or discounted interest rate.
Get in touch
If you’re considering overpaying your mortgage and want to know whether it might be the right decision for you, we can help. Email info@oundleandstamfordmortgages.com or call us on 01832 272653.
Please note:
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
