If you have savings and you’re earning less after tax than the mortgage rate, it may be worth using your cash to pay off some of your home loan.
Making overpayments on your mortgage may be one of the best financial decisions you make. You don’t need a lump sum – many mortgages allow you to pay off a bit extra each month.
Find out first if there is a minimum amount, a best time to make an extra payment, or whether there are any penalties for repaying all or part of your mortgage early. Most mortgage providers apply an early repayment charge if you decide to end your deal while you're within the deal period or overpay more than 10% of an outstanding mortgage balance in a year. Details of any specific Early Repayment Charge, specific to your mortgage, will be explained on your Mortgage Offer Document.
If you have an interest-only mortgage, check that extra payments will reduce what you owe – not just the interest. If you are able to afford to pay more, consider switching to a repayment mortgage, as the amount you owe will become smaller each month.
If you have savings and you’re earning less after tax than the mortgage rate, it may be worth using your cash to pay off some of your home loan. Although once you’ve paid off your mortgage, you can’t use it for anything else. If you think you may need this money later, consider an offset flexible mortgage. This lets you use your savings and the balance in your current account to reduce your mortgage interest – but you still have access to your cash if you need it. The added advantage is that as you’re saving rather than earning interest, it should be tax free; and more of your monthly repayments could go towards paying off your mortgage more quickly.
However, if you have other borrowings, it may be worth repaying those first as you might be paying more interest on loans and credit cards than on your mortgage.
Use our overpayment calculator to see how much you could save by making either extra monthly payments or paying a lump sum to your capital repayment mortgage.
- Repayment (capital and interest) mortgage
- Interest-only mortgage
- A mixture of repayment and interest-only
Repayment (capital and interest) mortgage
- Your payments are made up of interest and capital
- You gradually repay the loan over the term of your mortgage
With a repayment mortgage you pay interest on the amount you borrowed. You also pay off your loan by instalments. So over the years the amount you've borrowed reduces. Make all your repayments and by the end of the mortgage term you'll have paid it all off.
- Your payments only cover the interest on your loan
- At the end of the mortgage you have to pay off the amount you borrowed
With an interest-only mortgage, you'll have to make separate plans to pay off the sum you borrowed. This is normally done through an investment such as an endowment, ISA, or pension. If the investment doesn't perform as well as you'd hoped for, you'll still have to repay the mortgage at the end of the term.
A mixture of repayment and interest-only
You can combine both repayment types on one mortgage. For example if you have some existing investment plans you could use them to cover the interest-only element and have the remainder on a repayment basis.
The interest-only cap of 75% LTV still applies to combined mortgages. Any borrowing higher than 75% LTV can only be on a repayment basis.
There are two main ways you can pay back your mortgage and you can choose one or the other, or a combination of both.
Things to think about...
- The size of your mortgage, the interest rate and type
- Your savings and the money left in your current account each month
- Would it be better used towards paying off your mortgage?
It doesn't take much to wipe years off your mortgage – and save thousands of pounds in interest payments. This is because every time you repay some of what you owe, you are charged less interest, so more of your future payments go towards repaying the outstanding debt.
We are a member of the Financial Services Compensation Scheme (FSCS). The Scheme can pay compensation to customers if they are eligible and the Bank is unable to pay claims against it. Compensation limits for Mortgage advice and arranging (for business conducted on or after 31 October 2004) - maximum £50,000 i.e. 100% of first £50,000 per person. Further information is available here (650K PDF) or visit www.fscs.org.uk.