If you have a mortgage then you can pay more than your monthly mortgage payment and this process is known as mortgage overpay. If you have extra money then you can invest that money or you can also put more money towards your mortgage. Overpaying your mortgage can be an excellent way of saving money in interest and becoming mortgage-free sooner. However, is it really worth it to overpay your mortgage? Let’s find out below!
What is a Mortgage Overpayment?
When you make any extra payment over your usual monthly mortgage payment then it is considered a Mortgage Overpayment. You can either make an overpayment regularly throughout the year or you can also make a one-time overpayment. When you make an overpayment on the mortgage, you willingly pay more than the amount set by the lender. Overpaying your mortgage doesn’t mean you have to overpay every month, it’s totally up to you.
Why do People Overpay Mortgage Payments?
There are many reasons people overpay their mortgage payments. One main reason is people want to clear their debt as early as possible. This way they can save some money in interest. Below are some key reasons you can consider overpaying your mortgage payments.
- If you overpay your payments then you will be able to become mortgage-free sooner.
- Overpaying your mortgage payment will allow you to reduce how much interest you pay overall. If you pay all the debt much sooner than the actual time then you will pay less total interest over the lifetime of the mortgage.
- In, a mortgage, your monthly interest rate is calculated on the total outstanding sum of the loan. So, if you can reduce your debt amount through overpayments then your interest rate will be calculated on a smaller amount.
- By overpaying your mortgage payments you will be able to increase your house’s equity more quickly. Moreover, your loan-to-value (LTV) ratio will reduce and it will help you get more competitive mortgage rates if you try to get a new mortgage.
How much money can you Save by Overpaying Mortgage Payments
Mortgage overpayments can save you lots of money in interest during the loan term but how much you can save depends on quite a few things like how much you are overpaying and what is the interest rate of your mortgage. The below example will give you a clear idea of how much money you might be able to save by overpaying your mortgage payments.
Let’s say you have $100,000 on your mortgage with an interest rate of 3%. You have 20 years to pay the full debt. If your interest rate is fixed throughout the loan term then –
- If you pay an extra $200 as a regular monthly payment then you will be able to save $11,596 in interest in interest over the lifetime of your mortgage. Moreover, you will be able to clear the mortgage six years and seven months earlier than the actual loan term.
- If you pay an extra $100 as a regular monthly payment then you will be able to save $ 7,087 in interest in interest over the lifetime of your mortgage. Moreover, you will be able to clear the mortgage three years and 11 months earlier than the actual loan term.
- If you make a lump-sum payment of $20,000 then you will be able to save $13,760 in interest and can reduce the loan term by five years.
When is the Right Time for you to Make Mortgage Overpayments?
If you are planning to make mortgage overpayments then you should keep in mind that timing is very important in mortgage overpayment. If the lender allows you to make overpayments then you should find out how the lender calculates the interest rate. If the interest is calculated daily or weekly, then you can make overpayments whenever you like and you don’t have to worry about the timing.
However, if the interest is calculated monthly or quarterly then you have to be more strategic about the mortgage overpayments. In this type of situation, you should try to make your overpayments just before your interest is calculated. This way you will be able to save some money because the interest will be calculated on a lower loan amount. This is why most loan experts suggest that you should contact the lender and find out how the interest is calculated before making any decisions on mortgage overpay.
What to Consider before Making Mortgage Overpayments
If you have decided to make mortgage overpayments then below are some important factors that you should consider before taking the overpayment route. They are –
- First, you must check if there are any overpayment restrictions from the lender. Not every lender allows mortgage overpayments. Moreover, there might be a restriction on how much you can overpay of the total outstanding debt. So, contact the lender and find out all the details about mortgage overpayments. You should keep in mind that if you go over the overpayment limit then you have to pay an early repayment charge.
- If you have other debts like a credit card, auto loan, education loan, etc. then you should pay off those debts before making any mortgage overpayments. If those debts charge a higher interest rate than the mortgage interest arte then it will be wiser to clear those debts first.
- If you won’t be able to continuously make monthly overpayments then you can make occasional lump sum payments and it will be a much better option for you. You should keep in mind that there is no obligation to make mortgage overpayment so, if monthly overpayment or lump sum payments stretch your finances too far then it will be better for you to stick with your original mortgage payment plan.
- When you are making mortgage overpayments you should keep in mind that this process is not the same as putting money in your bank account. Once you make an overpayment, the money goes into an overpayments reserve and you won’t be able to withdraw the funds if you need the money. Therefore think clearly before making any mortgage overpayment.
Advantages and Disadvantages of Mortgage Overpayment
|Advantages of Mortgage Overpayment||Disadvantages of Mortgage Overpayment|
|You will be able to reduce your debt and interest cost||Making mortgage overpayment means you will miss out on investment opportunities|
|Mortgage overpayment will save you lots of money||Making mortgage overpayment won’t increase the value of the asset|
|You can quickly increase the house equity||You will miss the chance to diversify your investment|
|Loan-to-value (LTV) ratio will be reduced||Overpaying your mortgage will reduce the chance of minimizing tax breaks|
|You will be able to pay off the debt before the actual loan term||You might have to pay additional charges like Early Repayment Charges (ERC)|
|You can apply for a new mortgage with a better interest rate||Paying lump sum money as mortgage overpayment means you will lose access to the cash|
|You might be able to beat the low savings rate|
Is Mortgage Overpayment Worth It?
The answer to this question depends on quite a few things and the truth is mortgage overpayment is not the right option for everyone. Well, there are obvious advantages of mortgage overpayments but it should be right for your financial circumstances. If you have extra money then overpayment will get your mortgage cleared as fast as possible but if it put pressure on your current financial condition then I wonder whether it will be the right decision for you.
Therefore, you can consult with a mortgage adviser to run through your options. If you are financially solvent and if your main target of mortgage overpayment is to reduce your loan term then mortgage overpayment will be a good option for you. This way you will be able to save lots of money on interest.
FAQs about Should I Overpay My Mortgage? The Pros & Cons of Mortgage Overpay
Is it smart to overpay the mortgage?
If overpaying a mortgage won’t create any financial crisis for you then overpaying it can reap plenty of benefits for you. For example, overpaying a mortgage will lower your interest cost and you will be able to save lots of money.
Is it best to reduce mortgage terms or overpay?
Well, either reducing the mortgage term or overpaying will offer you some benefits and they do exactly the same thing so, any one of them will do the job. Reducing mortgage terms or overpaying will reduce the overall amount of interest you have to pay on the mortgage and help you save money!
What happens if I pay an extra $300 a month on my mortgage?
If you pay an extra $300 a month on your mortgage which is $100,000 with an interest rate of 3% then you will be able to save over $64,000 in interest and you will be paid off the mortgage over 11 years before the actual loan term!
Is it better to overpay the mortgage monthly or in a lump sum?
It is better to pay a lump sum than overpay a mortgage because paying a lump sum off your mortgage will save you more money on interest and you will be able to clear the mortgage faster.
Last Updated on August 7, 2022 by Ana S. Sutterfield
Magalie D. is a Diploma holder in Public Administration & Management from McGill University of Canada. She shares management tips here in MGTBlog when she has nothing to do and gets some free time after working in a multinational company at Toronto.