Should I overpay on my mortgage?
Wednesday, 18 March 2009 10:25
As interest rates are falling, homeowners on variable rate mortgages and tracker mortgages are seeing their repayments drop.
Should they use this extra cash to overpay on their mortgages? Daniel Barneslooks at giving your lender too much.
Banks are seeing a rise in the number of people choosing to repay their mortgages.
Simply overpaying now can shorten the term of your mortgage.
The Co-operative Bank estimates someone with a 25-year mortgage of £100,000, making overpayments of £50 a month could knock 3.6 years off the term of the mortgage.
This amounts to saving £12,000 over the term of the mortgage.
Meanwhile, Lloyds TSB says a customer who took out a variable rate mortgage in 2007, and maintained their payment at the December 2007 level, would have already reduced their term by over 11.5 years.
"My advice to these borrowers would be to use the current low interest rate environment and the consequent savings very wisely," says Ray Boulger at mortgage broker Charcol.
If you had kept your monthly payments at the same level that you were paying in September, with today's rate you could shave a very impressive ten years off the term of your mortgage.
Shortening your mortgage
Interest rates set by the Bank of England have fallen from 5.75 per cent in 2007 to one per cent. Those savvy enough to get on a tracker two years ago will have seen massive reductions on interest rates.
A borrower who took out a new 25-year base rate tracker mortgage at 6.12 per cent in September 2008 for £115,000 had initial monthly payments of £749, according to data from the Council of Mortgage Lenders.
Because of Bank of England interest rate cuts, their monthly payment would now be £494, and a saving of £255 per month.
Terry Jordon at the Co-operative Bank says: "We are encouraging overpayment. Overpayment is an option on all our mortgages and is a benefit for the customer and the lender."
Sarah Robson at the Council of Mortgage Lenders (CML) adds: "About 40 per cent of mortgage borrowers -those on tracker and variable rates - have seen some mortgage reduction due to the cut in official rates.
"They should consider overpayments as it reduces their mortgage balance and interest payments. It also protects their equity.
"Those on interest-only mortgages should consider switching to a repayment and add a safety net."
Passport to a better mortgage deal
One in ten of those making overpayments on their mortgages are doing so, so they can get a better remortgage deal down the line.
If you are a borrower near a loan-to-value threshold then seeking advice is even more important, says Mr Boulger.
"Playing a waiting game that will send you over one of these thresholds will be a losing game as rates move against you. Indeed, if you are at the top end of the scale you may not even qualify for a new mortgage."
Currently dropping off a tracker deal which is low and onto a standard variable rate mortgage may not result in much of a payment shock. But there is no guarantee rates will stay low for the next five years.
With longer term fixed rate mortgage deals seeing their rates dive, but the market is still far from open and the best deals are limited to those with the most equity behind them.
If you pay into your mortgage account and reduce the balance, you are reducing the LTV rate, so you could be able to get a better rate by being in a lower LTV band, Mr Jordon explains.
"We are seeing not surprisingly ten per cent of our customers overpaying, on average £110 a month," he says.
He explains people across the board - on trackers and fixes are choosing to overpay.
"But those on trackers have never experienced rate so low before."
Mr Jordon adds people are also seeing repayments drop with falling rates but are happy with their level of repayments and think they can afford to overpay.
With falling house prices, overpaying on the mortgage can also maintain the proportion of the home that is yours. For recent buyers overpaying could also protect them from negative equity.
Mr Jordan added with savings rates so low overpaying on your mortgage can be a very tax efficient way of saving.
Pitfalls
Firstly, you should only start overpaying on your mortgage if you can afford to do so.
Fiona Sharp, co-founder of Nottingham based-Finance4Women, is herself now overpaying on her mortgage.
However, she says: "I would never advise overpayment if they can't afford it."
She adds over paying helps to build a buffer, so if their lender allows and their mortgage is flexible, they could borrow later if they need to.
With the rapid rise in the cost of living over the last year now subsiding but still being felt with high gas and electricity bills the fall in monthly repayments will be seen by many as breathing space to get on top of their finances.
Also homeowners need to be aware of early repayment charges in their mortgage contract.
Repaying now might save money on mortgage interest, but if this is wiped away by charges, there is little reason to go ahead.
However Ms Shaw says fees should not be a problem in most cases.
Most lenders allow overpayment of up to ten per cent of the balance without penalties. Nationwide allows up to £500 overpayment a month irrespectively of the amount owned.
Also with recession biting Britain it is necessary to maintain a level a financial buffer for a rainy day.
One pitfall is if you overpay and have no savings and then can't borrow back, explains Ms Shaw.
There has to be a balance between flexible and having other savings.
With low interest rates a mortgage may not be the most expensive debt. If you do have free cash it is worth focussing on more expensive debts such as credit cards and personal loans.
Banks want you to overpay
Mortgage lenders are keen for borrowers to overpay on their mortgages and many are actively encouraging borrowers to overpay.
It may seem counterintuitive, as they are losing long-term profits, but in the short-term and in the current economic crisis, they really would like you to owe them less.
With less debt on their books, mortgage lenders are able to build on their capital ratios the buffer of cash they hold back to protect them from future losses.
Furthermore, with more cash being repaid, they are able to lend more, which the government is pressuring them to do.
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