07.18.2020

An Overview of Mortgage Overpayments

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Mortgage payments explained

Mortgage OverpaymentsThe monthly payments you need to make to fulfil your mortgage requirements are calculated by your mortgage lender when you are offered the loan. The purpose of the calculation is to ensure you have repaid the loan in full by the end of the mortgage term while also taking into consideration the following:

  • The interest rate upon which the loan was agreed
  • The number of years over which you will repay the loan
  • The total amount of the mortgage

If you make mortgage overpayments, you pay more toward the loan than you are required to.

Why make mortgage overpayments?

The reason why you may make mortgage repayments is to accumulate equity in your property with the ultimate intention of repaying the mortgage in full earlier and, thereby, reducing the amount of interest you pay.

For instance, if you had a mortgage of $250,000 at a 4% fixed rate over 25 years, by the end of the mortgage lifetime, you will have paid $145,877.63 in interest alone.

However, if you decided to make overpayments of $500 a month, you would pay off your mortgage much quicker and would pay $84,879.03 in interest instead, representing a saving of $60,999.00.

It’s important to note that mortgage repayments go directly toward paying off the principal loan, not the interest. As such, when you make mortgage repayments, you reduce the principal amount owed while directly decreasing interest.

If we return to the example outlined above, in addition to significantly reducing the amount of mortgage you repay, you’ll also pay off your loan 9 years, 8 months earlier than you would have done if you had not made any overpayments.

At a high level, making mortgage overpayments will provide you with an opportunity to save a lot of money over the long term; much more than you would be able to save in a savings account. Furthermore, by accumulating more equity in your property, you will be in a much stronger financial position if you wish to move property or remortgage your home.

You can use our mortgage overpayment calculator to determine how mortgage repayments can translate to cost savings.

When should you not make mortgage overpayments?

Mortgage overpayments are not advisable if the interest on your savings is higher than the interest rate on your mortgage

If your savings are earning interest at a higher rate than the interest rate charged on your mortgage, it makes more sense to keep your savings in a savings account. However, at present, this scenario is highly unlikely as interest rates throughout the world are currently relatively low.

If overpayments are not permitted on your mortgage

Some mortgages come with specific clauses that do not allow overpayments or penalise borrowers who make overpayments. As such, you should verify the conditions with your lender before you make any overpayments. In some cases, the penalty amount may exceed the amount of money you would save by keeping the money in a savings account. In scenarios such as this, it simply wouldn’t be cost-effective to make a mortgage overpayment.

When you have other debts that cost more other higher-cost debts

If you are repaying other debts that cost more than your mortgage, you should pay those off first before you move on to making mortgage overpayments.

If you may need cash reserves for unexpected costs

You should always make sure you have savings set aside in your bank for a rainy day to cover any unexpected costs that may come your way; for example, car costs, home maintenance, medical expenses, etc. If you put all your spare cash into making overpayments on your mortgage, you will leave yourself without any funds if unexpected expenses arise unless you have a flexible mortgage that permits you to borrow money from your mortgage in certain situations.

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