Homeowners should be feeling a little bit richer in spite of the recession. On average, they have 11% more disposable cash than a year ago, says a new survey from Halifax. It claims that a falling base rate means the average person with a mortgage has seen their monthly disposable income rise from £892 to £989. But if you are one of the lucky people on a low-interest tracker mortgage, don’t splash the extra cash; overpay your mortgage instead.
A mortgage is the biggest financial burden most of us ever carry. Reducing it cuts down the amount of interest you hand over to your provider and could shave years off the time it will take you to repay the debt, especially if interest rates start to rise. For example, if someone with an £80,000 repayment mortgage with the Nationwide overpaid by £75 a month at its base mortgage rate (2.5% in July), they could save more than £20,000 in interest and pay off the loan six years early, says Jill Insley in The Observer.
Another, and immediate, benefit of over-payments is that they reduce your loan-to-value ratio (if you have a mortgage of say £80,000 on a property valued at £100,000, this is 80%). Reducing this will help you to avoid negative equity, where your mortgage exceeds the value of your property. That can be crucial if you want to move. Even if you have positive equity, a lower LTV will get you access to a wider range of mortgages from ever-more demanding lenders.
But before you start ploughing extra money into your mortgage check your terms and conditions. Many mortgage lenders will only let you overpay up to 10% of your outstanding debt each year. Overpay by more than that and you’ll get whacked with a penalty charge, warns John Fitzsimons on Lovemoney.com.
Also check how your lender calculates interest and how overpayments will be taken into account. If interest is worked out annually, or overpayments are only credited to your account once a year, then overpaying monthly is pointless. Instead put the amount you would be overpaying into a savings account and then make a lump sum mortgage payment in the appropriate anniversary month. That way you can still reduce your mortgage and earn interest in the meantime.
If you are worried that overpaying now may lock up extra cash you might need in the future, an offset mortgage may be for you. These take any separate savings or current account balances you have and set them against your outstanding mortgage debt before interest is calculated. Offsetting therefore “typically brings forward the day when you can pay off your mortgage”, says Rosie Murray-West in The Daily Telegraph.
However, watch out for a couple of catches. First, you may get a better rate on your savings elsewhere (when comparing, note that interest from savings accounts is taxed, so a 3% rate is only worth 1.8% to a higher rate taxpayer). And if you already enjoy a low tracker mortgage rate, the best offset rate (3.34% for the first two years from First Direct says moneysupermarket.com) – may not compete.