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11th July 2024

With mortgage repayments having skyrocketed, overpaying your mortgage can help you save a lot of money in the long term. But how does it work and is it the right option for you?

impact of general election

It finally happened – after a tumultuous couple of years of rapidly rising costs, UK inflation fell back to the Bank of England's 2% target in May, the first time since July 2021. Yet while this is positive news overall, for mortgage borrowers the pain is unfortunately far from over.

That’s because the day after the inflation news was announced, the Bank of England’s Monetary Policy Committee voted to hold the base interest rate at a 16-year high of 5.25%.

Even when the Bank of England does start dropping the main rate, now expected by markets in August or September, it will be gradual and, crucially, highly unlikely to return to the rock bottom rates that defined the decade and a half following the global financial crisis.

“While we all got used to low mortgage rates post-2008, the reality is the rates we’re seeing today are pretty normal by historical standards,” says Marie Dalrymple, Equity Release and Mortgage Specialist at Ascot Lloyd. “They will come down when the Bank of England starts reducing the main rate, but don’t expect a return to the 1% and 2% rates we all got used to.

“I remember prior to 2007 when Nationwide brought out a five-year fixed rate at 3.5% and everyone thought that was amazing. Everybody was snapping it up because all the other rates were over 4%. I think around that level is probably where we are going to end up again.”

Reframing the discussion

Generally, if your mortgage rate is around the same or higher than your savings rate, or likely investment return, it can make sense to overpay your mortgage. This is also the case if you value certainty more than uncertainty because you know how much you are going to save if you reduce the mortgage balance. When mortgage rates were as low as 1% or 2%, few people saw much sense in overpaying their mortgage or paying it off in full because their savings could potentially render better results elsewhere albeit only by exposing that money to investment risk.

The rapid rise in interest rates over the last couple of years, and from such a low base, has seen people’s mortgage repayments skyrocket. Meanwhile traditional investment assets have seen more muted returns, with volatility affecting the equity markets and stricter legislation and tax policy making buy-to-let property a less attractive path to pursue.

These factors combined have transformed people’s attitudes towards their mortgage, causing many to consider using their savings to pay more than their lender requires them to or, if they’re able to, pay the whole thing off much sooner than they were originally planning.

"marie dalrymple inpageMarie DalrympleWhen mortgage rates were low and the likes of equities and buy-to-lets were performing well, people were reasonably confident they could get a better return from investing their savings,” says Dalrymple. “I remember there being a five-year fixed rate at 1% and clients wanting to take out mortgages just to free up cash to use elsewhere. Those days are gone.”

“The calculation turned on its head with rising rates and a stagnant economy meaning more limited returns on your savings. It's triggered a huge change in people's attitudes to mortgages. It's no surprise given how much mortgage repayments have risen. I had one client who went from paying £600 per month to £2,500. He had good savings and decided it would be best to just use them to pay off his mortgage in full. A lot of my clients are overpaying their mortgages. If they’ve got the funds, it’s becoming a popular route to take.”

How does it work?

Borrowers can pay off as much of their mortgage, penalty free, when they are not tied into a product with their lender. When they are tied to a product, typically lasting two to five years, their lender will charge an early repayment fee, typically between 1% and 5%, to overpay.

However, most lenders do allow borrowers to overpay up to 10% (some even 20%) every year, penalty free, even when they are tied into a product. You don’t pay any interest on the amount you overpay but remember you can't change your mind and get the money back.

It's important to look at the details of your lender's overpayment policy. Some allow you to overpay 10% a year of the original loan amount, so if the mortgage you took out was £100,000 you can overpay £10,000 per year even as the outstanding mortgage falls. Others apply the 10% to the balance, so the amount you can overpay falls as your mortgage does.

Overpaying on your mortgage doesn’t just mean you’ll be mortgage-free sooner and in the meantime pay interest on a smaller loan, but you also might get a cheaper rate when you next come to remortgage. That’s because, generally, the lower your loan to value (LTV), the ratio of what you borrow vs the value of your house, the cheaper the rates available to you.

The value of advice

One of the benefits of using a company like Ascot Lloyd to help arrange your mortgage or remortgage as well as for general financial planning is that you can get a more holistic view of your finances. A multi-lens approach helps you understand whether your retirement goals will be better served by using your savings to overpay your mortgage or invest elsewhere.

"That's why we have this extra service for clients in Ascot Lloyd because typically mortgage brokers are incentivised to recommend mortgages, whereas we won't do so if we think our clients are better off using their money elsewhere,” says Dalrymple. “Ascot Lloyd's clients always have me here even if they want to chat about their mortgage. Whether it comes to anything, sometimes it's just reassuring to chat with someone who understands the market.

"As mortgage rates fall and if assets such as equities continue to perform well, the overpaying discussion could change again. Everybody needs to keep having discussions to make sure that what they're doing is the best for them. With everything changing so much you just don't know what's out here so it's always good to speak with mortgage experts and financial advisers just to review your situation and know the best options for your savings. Ultimately making predictions is difficult, especially about the future. What you can probably be more confident about is predicting how you will feel when you finally pay off the mortgage and that’s something hard to put a price on."

Speak with your financial adviser directly or call our Client Services team about whether you should overpay your mortgage, please get in touch.

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