Savvy homeowners capitalise on current record low interest rates
As savings rates continue to offer poor returns, many people are turning to mortgage overpayments as a way to save money.
Overpaying cuts back on the overall interest a borrower has to pay over the term of the mortgage and actually cuts the length of the term, meaning further savings and a chance to be mortgage-free much more quickly.
Such savings have tempted many savvy homeowners to capitalise on the current record low interest rates to overpay their mortgages. Most mortgage lenders will let you overpay by up to 10 per cent per annum without penalty, while others will permit higher overpayments on variable rates.
Research conducted on behalf of Lloyds by Opinion Matters shows that around one in four consumers are already choosing to overpay their mortgage. Around half say they overpay their mortgage to reduce the term while just over a fifth say they overpay in order to pay less interest.
Lenders are still offering the best rates to those with greater equity and if borrowers can get their loan-to-value down below 60 per cent they will be seen as much more attractive to lenders and will be able to pick up a better rate when they come to remortgage.
Overpaying can particularly benefit first-time buyers if they have any spare cash. Flexible loans with an overpayment facility which allow unlimited overpayments can also be beneficial for borrowers requiring a high loan-to-value (LTV) loan but wish to make additional payments. This kind of deal will allow a first-time borrower to purchase a property with a lower deposit before house prices increase and also chip away at their LTV in readiness to remortgage to a better, lower LTV deal in future.
But borrowers should check with their own lender’s rules concerning mortgage overpayments. Pay more than the lender allows and borrowers will be penalised for doing so. And the penalties can be high, even a small overpayment of the matter of a few pounds can trigger the early repayment charge which is normally charged as a percentage of the mortgage amount or can be as much as six months’ interest.
If your lender will not let you overpay, or you are thinking of switching to a lender who is more generous in its overpayment terms, make sure you do your sums carefully. If you have to pay an early repayment charge to exit your existing deal and end up switching to a higher mortgage rate, work out whether it is in your interests to do so in order to increase your overpayments.
Borrowers need to be aware that it is unlikely they will be able to access the money after they have overpaid, so they must be totally sure they can afford it. While in the past lenders have allowed overpayers to also underpay, take payment holidays or draw down from the amount that has been overpaid, this is now rarely the case.
Also, in the current market, securing new borrowing facilities is more difficult, and the chance of being rejected is much higher. It is wise to retain a larger amount of spare cash before overpaying the mortgage as an extra safety net, especially with the increased risk of redundancy since the onset of the credit crunch.
While most lenders now calculate interest daily a few still calculate interest annually. Borrowers with a daily interest mortgage will see the benefit of a lower interest charge as soon as they make an overpayment but anyone with a mortgage where interest is calculated annually need to be careful when they overpay. Anyone with a mortgage on annual interest should check this out with their lender before deciding on the timing of any overpayments.
An alternative to making overpayments, especially for borrowers who are likely to need that money in the future, is a tax-efficient Individual Savings Account (ISA). This effectively means keeping the cash liquid and while inside the ISA wrapper ensures they do not pay tax on interest earned.
For those borrowers with an offset mortgage they have the best of both worlds in that their savings are being used to overpay plus they are able to access those savings at any time. Therefore, for those wanting to overpay on a regular basis and use their savings to help could consider an offset mortgage, although they should be prepared to pay a slightly higher mortgage rate to access this type of product.
With offset mortgages, instead of earning interest on the savings, the borrower offsets the interest they would have earned against the mortgage itself. An offset mortgage makes it possible to overpay without actually overpaying any more money each month; simply by placing savings in the offset pot the borrower is technically overpaying.
While an offset mortgage offers the highest degree of flexibility, many lenders’ mortgages are flexible and allow any overpayments to be used for payment holidays or to make underpayments. Conditions to be able to do this vary from lender to lender and so it is important to make sure any conditions imposed by the lender you propose using are acceptable before taking out the mortgage.
Many borrowers have this level of flexibility on the mortgage without realising it and some lenders offer an extra flexible feature on some mortgages in that overpayments can also be borrowed back as a lump sum at the mortgage rate. This degree of flexibility means that one can afford to make bigger overpayments than without this facility, as effectively the overpayments can become the savings account.
One other option to overpaying for anyone who is permanently able to commit to higher regular payments is to shorten the term if on a repayment mortgage or if on interest-only switch to repayment. However, not all lenders will let you switch back to interest only if you subsequently want to reduce payments. Similarly, while all lenders will allow you to shorten the mortgage term they may not allow you to subsequently lengthen it again, even to the original term.
