March 08th, 2023
The pros and cons of overpaying your mortgage in a time of high interest rates
As the cost of living crisis continues to have an impact on all our lives, it could become more challenging to pay any debt you have – in particular, your mortgage.
The week commencing on 20 March is the UK’s Debt Awareness Week, so now could be the ideal time to consider your next steps regarding your mortgage.
One factor that could contribute to your decision is that the Bank of England (BoE) raised the base rate to 4% in February 2023. This was its 10th consecutive rise since December 2021, when the rate stood at just 0.1%.
What’s more, following former chancellor Kwasi Kwarteng’s mini-Budget announcement in September 2022, the already-volatile financial markets experienced further downswings, sending some mortgage rates even higher than before.
So, if your fixed term is coming to an end, or your tracker- or variable-rate mortgage is reaching unaffordable levels, you could be considering using savings to overpay – or pay off – your mortgage.
Having a home that you own debt-free is a dream for so many people, and if you are close to paying off your mortgage, you may feel it is financially and emotionally more beneficial to simply pay the remaining debt.
However, repaying some or all of your mortgage debt while the base rate remains high could have some financial consequences down the line.
So, read on to learn the pros and cons of overpaying your mortgage this Debt Awareness Week.
The pros of overpaying (or paying off) your mortgage while interest rates remain high
- You could pay less interest overall by depleting your mortgage more quickly
It is likely the interest rate on your existing fixed-rate mortgage is lower than those currently on the market.
So, from now until your fixed rate ends, it could be helpful to slightly overpay your mortgage each month. Most lenders allow you to overpay up to 10% of your mortgage balance each year – and this strategy could deplete your debt faster on your lower rate.
Imagine you had a £130,000 fixed-rate repayment mortgage over 25 years, with monthly payments of £1,000, or £12,000 a year.
According to the MoneySavingExpert mortgage overpayment calculator, if you decided to pay an additional £100 a month, you would clear your debt almost six years faster. What’s more, you would save more than £45,000 in interest over the remaining term of the mortgage.
Alternatively, as your current deal ends, you could pay off a chunk of your debt as a lump sum, as part of remortgaging to a new lender or switching to a new deal. If you can afford to, repaying your mortgage more quickly could be a beneficial choice that reduces your long-term financial stress.
It is important to discuss the terms of your agreement with your lender before you overpay, as some overpayments could lead to an early repayment charge (ERC) – something we’ll discuss later in this article.
- You will be one step closer to owning your home outright
For many homeowners, the end goal is to own your home outright.
Living in your home debt-free could reduce your financial stress and free up funds to invest, spend on friends and family, or place in your pension fund.
By paying off your mortgage early before rates potentially rise even further, you will be one step closer to owning your home outright, helping to put you in a financially prosperous position for the future.
The cons of overpaying your mortgage debt in a time of high interest
- You could deplete your retirement savings too quickly
The potential benefits of overpaying (or entirely paying off) your mortgage are evident, but it is important to understand the long-term financial ramifications of doing so.
If you use funds from your pension, or you choose to liquidate other investments to pay off part of your mortgage, you could be left with a shortfall later in life.
Indeed, a survey of 2,000 adults published by Professional Adviser found that 44% of adults plan to liquidate investments to help with the cost of living crisis.
If you are one of these people, it could be helpful to consider how parting with these funds could affect you later, and make the necessary preparations to cover essential later-life costs, such as care.
- You could need the funds to pay more urgent costs
While it is understandable that you wish to prioritise repaying your mortgage, if you have a lump sum available for use, it could be wise to consider your whole financial plan before dedicating the funds to a mortgage overpayment.
Firstly, making sure you have money set aside in an emergency fund can give you the peace of mind that you have cash you can access if you face an unexpected bill or payment.
Then, if you have the following costs requiring attention, it could be wise to allocate funds to take care of them first:
- High-interest credit card loans
- Urgent repairs needed on your home
- Children or grandchildren who need financial support through the cost of living crisis.
So, before you spend a large amount on overpaying your mortgage, it could be wise to consult the expertise of a financial planner.
- There could be early repayment charges involved
Depending on the type of mortgage you have, and your lender, there could be ERCs involved in paying off your mortgage more quickly than you’d planned.
Indeed, Unbiased reports that early exit charges can reach between 1% and 5% of your outstanding mortgage value. Often, these charges decrease the longer you have held your loan, but this agreement can vary between lenders.
So, if you had £40,000 left on your loan, and decided to repay this as a lump sum before your term is over, a 1% charge would mean an added £400 – and a 5% fee would equal an additional £2,000 to pay.
Looking over your mortgage agreement with a financial planner could be constructive here. We can help guide you through overpaying your mortgage within the conditions of your loan.
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This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
Buy-to-let (pure) and commercial mortgages are not regulated by the FCA.
Think carefully before securing other debts against your home.