Should I pay off my mortgage early?

If you've found yourself in a position to pay off your mortgage early, or are thinking about making overpayments, you might be wondering if it's the right thing to do. This guide explores the advantages and disadvantages of paying off your mortgage before your term ends and highlights some alternative options too. 

Is it worth paying my mortgage off early?

Becoming mortgage-free as quickly as possible might seem sensible, but it might not always be the best financial move for your situation. If you've recently come into a large amount of money, such as from an inheritance, it’s important to consider the following before deciding to pay off your mortgage:

Interest rates

If you obtained a fixed-rate mortgage when interest rates were low, it might be worth considering whether you can earn more interest by keeping the money you would use to pay off your mortgage in a savings account with a higher interest rate. 

Let's look at an example: assume you have £80,000 remaining on your fixed-rate mortgage with three years left of your deal, charging 1.55% interest - approximately £3720. If you paid off your mortgage with your inheritance, you’d save approximately £3720. 

Instead of using your inheritance to pay off your mortgage, you put your money into a 3-year fixed-rate savings account offering 4% interest. Over the next three years, you could earn approximately £9,989.12 in interest. 

From the example you’d earn an additional £6269.12 by putting your inheritance into a high-interest savings account than if you’d paid off your mortgage. 

When calculating if you’ll be better off, remember to consider any tax you might need to pay on your savings.

This approach is likely to work best if you have a fixed-rate deal with a low-interest rate. If you have a standard variable rate mortgage, or a fixed rate deal with higher interest rates than a savings account, it may not work for you.

Early repayment charges

Early repayment charges are fees a borrower may incur for paying off or significantly reducing their mortgage balance before the agreed term. These charges are most commonly associated with fixed-rate mortgages, but they can sometimes apply to other types of home loans as well.

Early repayment charges can vary widely depending on the terms of your mortgage agreement. They are typically calculated as a percentage of the outstanding mortgage balance. The charges are usually higher in the early years of your mortgage and decrease over time as the mortgage term progresses.

It's essential for you to carefully review your mortgage agreement to understand the specific terms and conditions regarding early repayment charges. These charges can significantly impact the overall cost of paying off your mortgage early, so you should be aware of them and factor them in if you’re considering making additional payments or paying off your mortgage ahead of schedule.

Other debts

If you have other high-interest debts that exceed the interest rate on your mortgage, such as credit cards, personal loans or an overdraft, you may be better off paying these before repaying your mortgage early, but this may depend on how many years are left of your mortgage term.

Whilst your credit card or personal loan balances are likely to be smaller than your mortgage balance, the annual interest of those types of credit products tends to be much higher. 

Whilst you may be able to get a higher interest rate on your savings than on your mortgage, it’s unlikely that any savings account will offer a higher interest rate than most credit cards (outside of 0% deals) or personal loans.

Whether or not it’s a good idea to repay your mortgage early therefore depends on several factors. These include your financial circumstances, the type of mortgage you have, the remaining term of your mortgage, any fees from repaying your mortgage early, and your mortgage interest rate. If you’re considering making any changes to your mortgage, it’s vital you seek advice from a mortgage broker or independent financial advisor.  

Should I make overpayments on my mortgage?

You may be able to take steps towards becoming mortgage free quicker by making overpayments. Whether or not this is right for you will depend on your financial situation.

With most fixed-rate mortgage providers, you can make lump sum or regular overpayments of up to 10% of your mortgage balance per year without having to pay early repayment fees. If you pay back more than 10%, early repayment fees may apply. It’s important you check your own mortgage agreement so you have the full picture of your personal circumstances.

If you’re on a standard variable rate or tracker rate mortgage, you’ll often be able to overpay as much as you want without fees. However, it’s still important to check your mortgage agreement before going ahead.

Before you decide to make overpayments on your mortgage, you should consider the following:

• Reducing interest: One considerable benefit of overpaying your mortgage is reducing the amount of interest you’ll pay overall. This is because interest on a fixed-rate mortgage is charged as a percentage of your balance, so the lower your mortgage balance, the less interest you’ll pay. 

• Achieving mortgage freedom: The aspiration to become mortgage-free is common among homeowners. If you have the financial capacity to make extra payments, this can significantly accelerate the pace of achieving this objective. While your monthly repayment amount typically remains constant, your outstanding balance decreases. Consequently, there's potential to complete your mortgage payments ahead of the initially agreed term, assuming your mortgage rates remain unchanged. However, in the event of a remortgage where interest rates have increased, you might find it necessary to prolong the mortgage term in order to manage the repayment amounts.

• Financial stability: When making overpayments to your mortgage, you must make sure you still have enough money to cover your day-to-day expenses, manage any unexpected costs and work towards your other goals, such as having enough money for your retirement. If managed in a way you can afford, overpayments could increase your financial stability by making you mortgage-free quicker.

• Early repayment charges: As discussed above, it’s essential to check your mortgage agreement and speak with your mortgage provider, before making early repayments to see if you’ll be charged any fees. Depending on how high the fees are, you may want to consider putting the money aside in a high-interest savings account for now. You could then make the overpayment after any overpayment allowance you have refreshes or when your fixed-rate term expires.

• Other debts: Other forms of debt, such as credit cards, overdrafts and personal loans, tend to charge higher interest rates than mortgages. If you have some of these higher-interest debts, you may want to consider paying them off before making early repayments on your mortgage.

Is it better to overpay my mortgage monthly or a lump sum?

The decision between making monthly overpayments or a lump sum towards your mortgage depends on various factors, including your financial situation, goals, and the terms of your mortgage. Here's a breakdown to help you decide:

Monthly Overpayments:

• Pros: Making regular monthly overpayments can help you steadily reduce your mortgage balance over time. It can be a manageable way to allocate extra funds without putting too much strain on your finances. These smaller, consistent overpayments can add up and potentially save you significant interest over the life of the loan.
  
  
• Cons: Monthly overpayments might not have an immediate impact on your monthly payment amount or the loan term. Also, you might have to wait a while to see substantial changes in your remaining mortgage balance.

Lump Sum Payment:

• Pros: A lump sum payment can have a more immediate impact on reducing your mortgage balance. It could potentially shorten your loan term and save you a substantial amount on interest payments.

• Cons: Depending on the size of the lump sum, it might strain your finances more than monthly overpayments. Additionally, putting a large sum into your mortgage means you might have less liquidity for other financial goals or emergencies.

Considerations:

• Financial Situation: Assess your current financial stability and ability to allocate funds. A lump sum might be suitable if you have extra savings available.

• Interest Rates: If your mortgage interest rate is higher than what you could potentially earn from investments, it might make more sense to pay down your mortgage faster.

• Loan Terms: Check if your mortgage has any penalties for lump sum payments or if there's a maximum annual overpayment limit.

• Other Financial Goals: Consider if you have other financial goals (like building an emergency fund, saving for retirement, or investing) that could be impacted by making a lump sum payment.

In many cases, a balanced approach could work well, where you allocate some funds for monthly overpayments and save a portion for periodic lump sum payments. It's advisable to consult with a financial advisor or mortgage specialist to determine the best strategy based on your specific circumstances.