How do mortgage overpayments work and when should I make them?

It can be a great way to save thousands on interest - but make sure you know the rules of your deal

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If you have spare cash, making mortgage overpayments can be a no-brainer. By doing so you can save thousands of pounds over the life of your loan.

Mark Harris, chief executive of mortgage broker SPF Private Clients, says: “Overpaying on your mortgage, if you have the spare funds available to do so, is a great way of reducing the interest you pay. As you clear the balance sooner, you end up with a shorter mortgage term so end up paying less interest.”

However, overpayments aren’t always the best option. Not all mortgages allow them, and some limit how much you can overpay.

Plus, your spare cash might earn more or be put to better use elsewhere.

How do mortgage overpayments work?

When you take out a repayment mortgage, your lender will calculate the fixed monthly amount needed to ensure the loan – and all the interest – is fully repaid by the end of the term.

If you pay more than this set amount, you’re making a mortgage overpayment.

Overpaying your mortgage can reduce the total interest you pay and may help you clear your mortgage sooner.

There are two main ways to make mortgage overpayments: lump-sum payments or regular monthly overpayments.

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Lump-sum overpayments

If you have spare cash – perhaps from savings, a bonus, or an inheritance – you can make a one-off payment to reduce your mortgage balance. For example, if you owe £300,000 and pay a £50,000 lump sum, your remaining balance will drop to £250,000.

When you make a lump-sum overpayment, your lender will usually give you two choices: you can either reduce your future monthly payments while keeping the mortgage term the same, or keep your monthly payments as they are and shorten the mortgage term.

"Reducing your payment will mean the overall length of your mortgage remains the same, but your obligated payment reduces. Alternatively, overpayments that reduce the term will retain the same monthly payment but reduce the mortgage term,” says Jonathan Bone, head of mortgages at online broker Better.co.uk.

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“Both options will save you money in the long run, but reducing the term will do so more effectively. The downside is that your monthly commitment hasn’t reduced.”

Monthly overpayments

If you have spare income each month – from a payrise or income from a lodger, for example – you can opt to pay more than your standard mortgage payment.

For example, if your monthly payment is £1,000, you might increase it to £1,200.

This approach helps you shorten the overall term of your mortgage, allowing you to pay it off sooner and reduce the total interest charged.

How much money can you save?

Overpaying your mortgage could result in saving thousands of pounds over the term of the loan.

For example, if you had a £300,000 repayment mortgage with 20 years left to go with an interest rate of 4 per cent, your normal monthly payment would be £1,818.

If you increased your monthly payment to £2,000 (an overpayment of £182), you’d pay off your mortgage two years and seven months quicker. You’d also reduce the total amount of interest you paid by £19,690.

If you had the same mortgage and made a lump sum overpayment of £20,000 and kept your monthly payments the same, you’d reduce your mortgage term by 1 year and 11 months. You’d also reduce the total amount of interest you paid by £22,630.

If you did both these things – made a one-off overpayment of £20,000 and then overpaid by £180 a month – you’d reduce your term by four years and two months and save £38,180 in interest.

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How much can you overpay?

Not all mortgages allow overpayments, so check your mortgage agreement or speak to your lender first. What you’re allowed to overpay – and by how much – depends on your specific mortgage product.

For example, your mortgage might let you overpay up to a set percentage of the original loan each year (typically around 10 per cent) or overpay a fixed amount each month (for example, £500).

“If you have a fixed-rate mortgage, there will typically be a limit to the amount you can overpay without penalty,” explains Harris, “Most lenders have a 10 per cent overpayment limit but some allow 20 per cent and even rarer still, some will allow 50 per cent (like Suffolk Building Society). Should the borrower overpay by more than the limit, an early repayment charge is levied.”

If you’re on your lender’s standard variable rate (SVR), you can normally overpay as much as you want. Flexible and offset mortgages usually allow unlimited overpayments, and many lifetime trackers do too.

Should I make overpayments?

Before making mortgage overpayments, consider whether your money could work harder elsewhere.

Any credit card debt or personal loans will usually have higher interest rates than your mortgage – so pay these off first.

If you don’t have other debts, think about whether your money could make more in a savings account or in investments than what your mortgage interest is costing you.

Do the sums and see what’s best - including whether you’ll need the cash further down the line.

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