Will Overpaying The Mortgage Pay Off?Posted on: 19 January 2009 by Gareth Hargreaves
Lenders have advised homeowners to overpay mortgages and protect from falling house prices.
The Council of Mortgage Lenders (CML) says those benefiting from lower rates should reduce their mortgage balances, and has warned of tougher times ahead.
CML director general, Michael Coogan, says, “Borrowers who are benefiting from lower mortgage rates should overpay if they can afford it to reduce their mortgage balance and protect themselves against falling house prices.”
So if you have benefited from lower payments, should you overpay?
Why Are Lenders Advising This?
The advice came as the CML released new figures showing the number of mortgages for homebuyers hit another record low in November, falling to 33,000 down 59% on the same month the previous year.
It has forecast even tougher times ahead for the mortgage market and suggested house prices still have some distance to fall.
Banks and building societies are currently attempting to rebuild their defences after overstretching themselves in recent years.
They are desperate for cash and encouraging those on low rates to overpay their mortgage to shore up their finances and give them more money to lend out to others at higher rates.
Why Would You Want To Overpay?
The impact of tumbling house prices is that homeowners are seeing falling loan-to-values, the measure of their remaining mortgage as a percentage of their property's value.
At the moment, mortgage lenders are only offering their best deals to those with low loan-to-values of 60% - meaning to get the best deal a remortgager or homemover needs a 40% deposit.
By overpaying, borrowers can reduce their loan-to-value and increase the chance of a better mortgage deal. Overpaying a mortgage also makes a big difference to how long it takes to clear.
If you overpaid £100 per month, on a £100,000 mortgage taken out over a 25-year period, averaging an interest rate of 6%, you could save £27,039.37 and take six years off the life of your mortgage.
Mortgage Overpaying Vs Savings
The other advantage of overpaying is that it is more tax efficient than savings. If you are a taxpayer you will have tax deducted from your savings, either at 20% or 40%.
Invest £10,000 in 3.5% savings account and as a basic rate taxpayer your return of £350 will diminish to £280, or as a higher rate taxpayer it will fall to £210. This reduces your return to 2.8% or 2.1% respectively.
If you pay the money off the mortgage there will be no tax deduction. A borrower with a 3.5% mortgage rate would need to get a savings rate of 4.4% and a higher rate taxpayer 5.8% to match the tax advantages of overpaying a mortgage.
Why Wouldn’t You Want To Overpay?
Before you even think about overpaying your mortgage, make sure that your lender will not hit you with early repayment charges for doing so. Most fixed and tracker rate mortgage allow at least some overpayments, those on SVRs should be able to overpay as much as they like as will those on lifetime trackers.
The important thing to consider is will you need the money? Some mortgages allow you to borrow back overpayments – with others once you have overpaid you cannot get the money back.
With concerns over jobs, it is vital to have some rainy day cash set aside, with at least three months post tax pay ideal, and six even better.
Offsetting – The Best Of Both Worlds
One option for those who can move mortgages is to take an offset mortgage. These work by setting savings against the outstanding mortgage, with borrowers only paying interest on the balance.
If you have a £150,000 mortgage and £50,000 savings, then in return for not receiving interest on the savings you will only pay interest on £100,000 of the mortgage.
By offsetting you can keep savings accessible, but still pay off your mortgage quicker or get lower monthly payments. Obviously, if you take your savings out your payments will then go back up.
First Direct, HSBC's online and telephone bank, currently has offset base rate trackers at 3.39% - base rate plus 1.89% - for those with a 20% deposit.
Are you overpaying your mortgage?
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