Homeowners should be overpaying their loans while interest rates are so low, writes Jeff Salway
Scottish homeowners have an opportunity to slash thousands of pounds and several years off their mortgages – but many are failing to take advantage.
More people could be overpaying their home loans while interest rates remain at rock-bottom, experts say. Those who can afford to raise their monthly repayments even modestly can clear their mortgage early, yet few homeowners are taking advantage.
Nationwide Building Society this week became the latest lender to ease restrictions on overpayments. Borrowers taking out new mortgages from 29 May will now be able to overpay up to 10 per cent of their mortgage each year without incurring an early repayment charge (ERC), improving – at least for borrowers with larger mortgages – on the previous maximum of £500 a month. Existing borrowers don’t benefit from the change, however.
The move brings Nationwide in line with the market norm, as most lenders cap penalty-free overpayments at 10 per cent of the outstanding balance each year.
And while there has been some pressure on lenders to make it even easier for borrowers to overpay without penalty, mortgage experts believe more homeowners should take advantage of the existing opportunity.
Clare Francis, consumer finance expert at MoneySupermarket, said: “If you have money to spare each month, it is well worth considering making overpayments on your mortgage. Not only will it mean you pay off your mortgage more quickly, which could save you thousands of pounds in interest, but could also make it easier to remortgage.”
While the prospect of diverting extra money to your mortgage may not appeal in the short-term, the idea of reducing your mortgage term is attractive.
“It is a message I try to get out there to borrowers that you can clear more when you can afford – paying off 10 per cent extra a year will save you years and thousands of pounds,” said Mark Dyason, director at Edinburgh Mortgage Advice.
An additional motivation may lie in the paucity of inflation-beating savings account currently available. Just a handful of tax-free individual savings accounts (Isas) offer a real return once inflation is factored in, and that only after a surprise dip in the cost of living last month. With savings rates falling in recent months and few expectations of that trend reversing any time soon, it’s a good time to review how best to use any spare cash you have lying around.
“With savings rates so low, paying off your mortgage may seem like a better option than putting your spare cash into an account paying next to no interest,” Francis pointed out.
An added bonus of overpaying is that by boosting the amount of equity you have in your home, you improve your chances of getting a decent deal when you next come to remortgage.
Mark Harris, chief executive at independent mortgage broker SPF Private Clients, said: “In the shorter term, with lenders continuing to offer the most competitive mortgage rates to those with sizeable amounts of equity in their homes, it makes sense to improve your equity position if you can. Overpaying will make you more attractive to lenders and make it easier for you to remortgage.”
Overpaying isn’t for everyone, however. Those for whom it may be particularly suitable are people whose pay fluctuates, perhaps because they rely on bonuses. Some lenders will allow borrowers to overpay without penalty whenever they can rather than by a set amount each month, although such flexibility will often be discretionary.
Homeowners with interest-only mortgages may especially benefit from overpaying. Few lenders now offer interest-only loans and those that do have imposed tighter criteria, creating problems for borrowers without robust repayment plans in place. Many interest-only borrowers will be forced on to normal repayment plans when their term ends, at which point the amount of equity they have in their home will be key.
“If you can’t afford to go on to full repayment at this point, overpay what you can afford because it reduces the loan, interest and loan-to-value and gives you a better chance of owning your home outright in the future,” said Dyason.
So when isn’t it necessarily a good idea?
“When interest rates are at record lows, it makes sense to overpay on your mortgage,” said Harris. “However, the reality is that with rising living costs, many people will have been using the savings made each month for other outgoings.”
That also means ensuring you keep some cash back for emergencies. While the temptation to reduce the mortgage term may be a strong one, using all the disposable income you have to achieve it is not advisable, noted Adrian Anderson, director of mortgage broker Anderson Harris.
“While overpaying is a wise move, make sure you keep some money back for emergencies,” he said.
“Money overpaid is notoriously difficult to get back again so don’t plough all your savings into the mortgage, keep some back to pay for a new boiler, washing machine or unexpected outgoing.”
One way around that is an offset mortgage, said Francis. “With an offset, your savings are linked to your mortgage to reduce the amount of interest you pay on that debt. So if you have a £100,000 mortgage and £20,000 in savings, you’d only be charged interest on £80,000.”
Crucially, your savings are kept in a separate account and you can access them at any time.
Take care also to avoid overpaying by more than you’re allowed to. If your lender allows overpayments of 10 per cent of your balance each year, you could be hit with a hefty ERC if you exceed that limit even by a few pounds.
See the article on the right for more on the overpayment restrictions imposed by different lenders.
Who charges what among big lenders
Overpayments of up to 20 per cent can be made to the standard monthly repayment without incurring an early repayment charge. Early repayment charge (ERC) applies if you increase your standard monthly payment by more than 20 per cent or repay over and above your standard monthly payment during a fixed or discount rate period. This does not apply to tracker rates or the HSBC variable rate, where unlimited overpayments are allowed without incurring an ERC.
Sometimes ERCs are payable and apply until a specified date. So if you repay your mortgage in full, or repay more than 10 per cent in any year, you may be charged a fee that will be a certain percentage of the amount you repay.
NATIONWIDE BUILDING SOCIETY
You can make overpayments of £500 or less per month without incurring an ERC. If you overpay by £500.01 or more in one month you will incur an ERC that is payable on the entire overpayment amount. New products released on 29 May allow overpayments of 10 per cent a year without charge.
10 per cent of outstanding mortgage balance each year without extra charge.
Overpayments of more than 10 per cent of your mortgage balance incur an ERC. These charges differ by product type and term.
10 per cent of outstanding mortgage balance each year without extra charge. Once the term of the mortgage deal is over, you can overpay by any amount with no extra charge.
HALIFAX (BANK OF SCOTLAND)
Overpayments of up to 10 per cent a year of the amount outstanding can be made without an ERC. If a customer’s mortgage rate is not subject to ERCs they can make unlimited overpayments.
Overpayments of up to 10 per cent of the outstanding balance a year without an ERC.
Overpayment – how much you can save
Loan – £150,000
Term – 25 years
Mortgage rate – 3 per cent
Monthly payment – £711
Overpay £150 a month – Saves £16,332 in interest over the term and clears the debt in year 20.
Overpay £250 a month – Saves £23,191 in interest over the term and clears the debt in year 16.
Loan – £200,000
Term – 25 years
Mortgage rate – 3 per cent
Monthly payment – £1,186
Overpay £150 a month – Saves £18,242 in interest over the term and clears the debt in year 22.
Overpay £250 a month – Saves £27,221 in interest over the term and clears the debt in year 20.
Source Anderson Harris