Mortgage overpayments: A strategic approach to combating rising interest rates

More and more property owners are increasingly addressing the issue of mortgage overpayments to counter rising interest rates. One of the UK’s largest mortgage providers, Santander, saw its customers’ overpayments increase by 78% between 2022 and 2023. But this strategy is not always the most beneficial.

Making extra payments on your mortgage can reduce the interest your lender charges and speed up the process of becoming debt-free, with minimal overpayments able to shave months or even years off the total term of your mortgage.

It is often a good idea to weigh up the interest you pay on your mortgage against the interest you earn on savings. In some cases, it may be more beneficial to put the money into a savings account.

Many lenders allow customers to repay up to 10% of their mortgage balance annually without penalty. One exception is NatWest, which last year increased the overpayment limit to 20%. The level of early repayment penalty varies between lenders, but is typically between 1% and 5% of the outstanding mortgage amount.

Customers can pay off their mortgage overpayments either through monthly additional payments or through lump sum payments. While mortgage rates have fallen slightly in recent months, fixed rate arrangements are still expensive compared to the low rates of a few years ago.

For example, on a £350,000 25-year mortgage with a two-year fixed rate of 5.58%, overpaying by £200 per month can save you £56,022 in interest and reduce your debt by four years and one month. By contrast, the same amount in a savings account with an interest rate of 3.1% would only earn £20,504 in interest over the same period.

Regular overpayments of small amounts, such as £10 a month, can also result in significant interest savings over the long term. In the same mortgage example, a £10 overpayment a month would result in an interest saving of £3,464 and a reduction in the term by two months.

Homeowners with more equity may be able to negotiate better interest rates when refinancing by transferring money. This can lower the loan-to-value (LTV) ratio of the mortgage and open up a wider range of advantageous interest rates.

However, you should be careful not to overextend yourself financially. In some cases, it might make more sense to set aside savings that can be used to reduce the mortgage when the current mortgage agreement expires.

There is no definitively right way. What matters is whether other debts, retirement provisions and emergency reserves are secured.

If savings currently yield a higher return than mortgage interest, holding onto savings may be a more worthwhile alternative. For example, Cahoot currently offers 5.2% on an easy-access savings account.

For young homeowners, investing in retirement savings could be a better strategy than overpaying on a mortgage, according to research by Interactive Investor.

Ultimately, the decision depends on what gives you more peace of mind.