How do mortgage overpayments work? Is it worth it, is it better to overpay mortgage monthly or in lump sum

The Bank of England raised interest rates once again on Thursday (2 February).

Its base rate now sits at a fresh 14 year high of 4% - 0.5 percentage points higher than the level it was set at in December 2022. Designed to bring down inflation, the economic mechanism makes borrowing money more expensive.

Interest rates have rocketed in recent months, particularly since Liz Truss’s mini budget crashed the value of the pound and threatened to make inflation much worse. It means mortgage payers have faced a big cost of living squeeze in the form of major hikes to their monthly repayment costs, while prospective buyers have been put off or priced out of entering the housing market - something that has led to a fall in property prices.

If you’re one of an estimated 1.4 million people coming to the end of their fixed rate deal in 2023, you may be wondering how you will secure a new deal without breaking the bank. One method you could use is overpaying your mortgage - an option that has become increasingly popular since interest rates have soared.

But how does this work - and what considerations do you need to make before overpaying?

What is a mortgage overpayment?

A mortgage overpayment is when you pay more money back to the lender than they have requested. You might do this on a monthly basis, or with a lump sum once a year.

The reason why this may be beneficial is that you’re reducing your loan to value (LTV) ratio, i.e. the amount of loan you have left to repay compared to the value of your property. In essence, you’re getting rid of both existing debt and future interest payments.

By lowering your LTV ratio, not only will you have less mortgage to repay, you may get access to cheaper fixed rates (lenders tend to separate LTVs into bands to calculate this). It could also reduce the length of time you’re paying off your mortgage for, which means the loan is likely to be cheaper overall.

At present, there is potentially a major benefit in overpaying your mortgage if your fixed rate is much cheaper than those currently available on the market. With elevated interest rates likely to be with us for at least the next two years, you could easily save yourself a five-figure sum by overpaying on your current low fixed rate (if you have enough money going spare).

According to calculations by Money Saving Expert Martin Lewis, overpaying by £50 a month (on a typical £150,000, 25 year mortgage with a rate of 4%) over the term of your mortgage could save you almost £10,000 and chop two-and-a-half years off your repayments. His site has a mortgage overpayments calculator you can use to work out how much you could save.

What do you need to consider before overpaying your mortgage?

Before you overpay, you should find out whether your lender will allow you to make an overpayment. You also need to check whether or not there is a limit on the amount you can overpay.

Most fixed-rate mortgages and some tracker mortgages have an overpayments limit of 10% of your total outstanding mortgage balance per year. There is often no limit on a standard variable rate (SVR) mortgage - but they tend to have higher interest rates, so the benefit of overpaying reduces.

Be sure to chat to your lender to find out what the rules are around overpaying. If you do overpay, they will typically give you the option of reducing the following month’s payment, or reducing the term of your mortgage (by keeping payments at an elevated rate until the term ends) - the latter being the option to go for if you’re doing it with the intention of dropping your LTV ratio.

If you have lots of cash to hand, you can overpay using a lump sum. But be sure to check when your annual deadline is with your lender, and ask them to calculate what mortgage you will have left to pay off once the payment has been made.

Another consideration is whether it’s worth saving the money rather than overpaying your mortgage. If the interest rate being offered for the mortgage is above or roughly equal to the best savings account rates on the market, it generally makes sense to opt to overpay your mortgage. It all depends on your circumstances (e.g. how much mortgage you have left to pay off and what your mortgage term is)

Mortgage overpayment calculators

The major lenders use slightly different calculations on mortgage overpayments. Below, NationalWorld has listed most of the major UK lenders and links to their respective calculators:

• Halifax mortgage calculator here.
• Nationwide mortgage calculator here.
• Santander mortgage calculator here.
• Lloyds mortgage calculator here.
• TSB mortgage calculator here.
• Natwest mortgage calculator here.
• Bank of Scotland mortgage calculator here.
• HSBC mortgage calculator here.