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I'm coming to the end of my fixed mortgage, and starting to think about remortgage deals. My remaining term is 30 years with outstanding amount of £122,000. I'm able to save between £900-1500 a month, so my main goal is to overpay my mortgage and significantly reduce the mortgage term.

One of the deals I've come across is 2 years fixed, allowing me to overpay 20% of outstanding amount each year, and with a 4.99% interest. The main thing is by default overpaying reduces the monthly amount rather than the mortgage term. To reduce the mortgage term I would need to apply for that, with a £35 fee. If I want to do so every month then that's an extra £35 monthly, which is not ideal.

Would there be a difference if I overpay monthly to reduce the monthly amount, and at the end of the year apply for a term reduction, or am I better off paying a lump sum every year and reducing the mortgage term on each annual lump sum payment? Or should I look for a good saving account, and make lump sum overpayments every year from savings?

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  • With the (or a different) additional fee, can you overpay more than the 20%? And/or what are the fees to refinance? Otherwise, after 2-5 years, your 900-1500£/month will be more than the 20% outstanding balance.
    – Solarflare
    Commented Mar 7 at 17:52
  • No the max allowance is 20% of outstanding balance. I guess I could overpay within the 20% allowance, and at the end of the 2 years fixed period overpay any extra on a remortgage
    – P P
    Commented Mar 7 at 18:49
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    I’d open my spreadsheet and start plugging in numbers and formulas. Nothing “fancy” like exponents, just the effect of each payment each month. Do that for monthly overpayments and annual overpayments.
    – RonJohn
    Commented Mar 8 at 4:50
  • Another option for your spreadsheet to consider would be an offset mortgage - the rate is higher, but arbitrary 'overpayments' (effectively) are free
    – AakashM
    Commented Mar 8 at 9:15
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    It looks as if you are unlikely to overpay more than "20% of outstanding amount each year" since that is £24,400 initially and slightly less later. Even if you could overpay more, a natural thing to do could be to overpay as much as you wish over the two years up to that limit so avoiding the fees, and then after the two years take a new deal with a shorter term going forward if you then want it.
    – Henry
    Commented Mar 12 at 11:00

3 Answers 3

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If you overpay, your term will shorten - unless you apply to readjust to a lower monthly rate (after the fixed rate expires). If it costs, readjust it as few times as practical.

To get the best reduction, get as much "overpayment for your money" as you can within any yearly limit. In terms of best value for money, in short: Pay early unless there is a suitable savings account that lets you gain more interest than the interest that would be saved on the mortgage.

That depends on the savings accounts available and whether you have the lump sum already. The simplest cases (best first):

  1. You have the lump sum and can put all of that immediately into a savings account with a higher rate (after any tax on interest) than the mortgage: Put it into the savings account and use the savings plus interest to overpay when you want or when the savings account stops being beneficial.

  2. You have a lump sum, but cannot find a savings account with an interest rate better than the mortgage: Overpay the lump sum.

  3. You do not have a lump sum, but you have a savings account with higher interest rate than the mortgage (after any tax on interest): Pay into the savings account monthly and use the savings plus interest to overpay when you want or when the savings account stops being beneficial.

  4. Stating the obvious - with no lump sum or suitable savings account: Overpay monthly.

Fitting in somewhere around 2) there are cases, where it gets harder to judge. For instance if you can find a savings account, that has a good rate but only allows a smaller amount to be paid in per month. Then you may need to get the spreadsheet out if you have time.

For example let's say a bank offers a savings account with 8% interest allowing £300 to be paid in per month for one year. That would only be worth using if the mortgage rate is below approximately 4%. Otherwise it is better to pay £1500 off the mortgage immediately, as you have that amount available.

This is because for the first payment you get 8% (the full year's interest) and for the last payment you get less than one percent (one month's interest) - the average for all the payments being around half the yearly interest if you want to be conservative.

If the mortgage rate is below 4%, then you could use that savings account plus monthly overpayments to get a little more from your money, ie. pay £300 into the savings account every month and make monthly overpayments on top of that as you can afford. Then make an overpayment from the savings plus interest after a year.

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  • Thanks for the info. So if I do the last option and just overpay monthly, without reducing my regular repayment amount, then after the fixed rate period for example, my outstanding mortgage balance would be reduced more than normal, and therefore I can remortgage with a shorter term, but keeping the same regular payments (if interest rate is similar)? I have read if for example I overpay the bank might reduce my repayment amount, which is apparently not beneficial
    – P P
    Commented Mar 8 at 14:23
  • Yes, if remortgaging at "the same rate", you should be able to shorten the term (or reduce the monthly payments). I'd say both are beneficial, depending on what you require. Shorter term would mean less interest paid.
    – nsandersen
    Commented Mar 11 at 7:50
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Unless you have prepayment penalties, then you don't need to reduce the term of the loan; overpaying will take care of that naturally so long as any overpayment goes to reduce the principal. Whether that reduction in principle reduces the term or the paymeny does not matter. I would check your loan documents or talk with the bank to see if they allow overpayments and how they are applied.

Suppose your mortgage payment is £1,000, and right now £200 is principal and £900 is interest. If you overpay by £500, all of that will go towards principal, reducing the interest amount next month. If you ask to re-amortize to a shorter term, the interest amount the next month will be the same (it's calculated from your remaining principal) and the principal amount will increase. It's the same effect as if you overpaid to the same amount as the new calculated monthly payment. Reducing the term just forces you to pay more each month. If you do it on your own diligently you can get the same effect without having to pay a fee.

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  • They will have prepayment penalties if they go over the 20% "allowed" overpayment described in the question. Commented Mar 7 at 18:44
  • Yeah I'm only allowed to overpay 20% of outstanding balance during the 2 year fixed period
    – P P
    Commented Mar 7 at 18:47
  • I don't think that changes my answer, but I may be missing something. Regardless of how much you overpay, changing the term only affects the minimum monthly payment - if you're overpaying anyway, it doesn't matter what the minimum is.
    – D Stanley
    Commented Mar 7 at 19:36
  • You can either (a) reduce the term and leave the standard payment unchanged, or (b) reduce the standard payment and leave the term unchanged. In either case you are limited to a certain overpayment on top of the standard payment. So choosing (a) means you can repay more in total. Commented Mar 7 at 20:38
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    I think I see what you're saying, if the payment goers down but I pay the same amount, the "overpayment" amount is higher and I use up the 20% more quickly.
    – D Stanley
    Commented Mar 8 at 14:04
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My mortgages were all in the US. Maybe mortgage contract terms are different in the UK. I'll answer this from the US point of view. If this isn't applicable to the UK ... sorry.

In the US, every mortgage I ever had allowed me to overpay with no fee or penalty. Overpaying one month did not reduce my payment in the following months. It meant that I would pay off the mortgage sooner. If I wanted to reduce my monthly payment, I had to refinance the mortgage.

You are better off to make overpayments monthly rather than saving them up and making one big overpayment at the end of the year. By making payments monthly, you reduce your balance sooner, and thus reduce your interest charges.

If you plan to keep overpaying, then there's nothing to gain by refinancing to get a lower monthly payment. You're going to pay more than that anyway. The only time I ever refinanced was to get a lower interest rate.

Many banks offered me a "deal" where I could pay a fee to pay extra on my monthly payments. But I could also pay extra without paying any fee, by just giving them more money, so there was absolutely no reason to pay the fee. Paying the fee just meant that they would send me a statement saying "here's the amount you said you wanted to pay" instead of me remembering it. Or for more recent loans, that they would automatically deduct the overpayment from my bank account rather than me having to log in and initiate the transaction. I suppose if I was very busy or very lazy, it might be worth paying someone $20 or $30 to save me the 15 minutes of initiating the transaction. But I'm not rich enough for my time to be worth that much.

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  • I can't speak for all UK mortgages, but in my case there was a significant penalty.  (IIRC, in each year it allowed 10% overpayment; anything over that incurred a penalty of something like £6000.)  So your USA experience clearly isn't universal.  (In my case, by default it reduced the monthly fee, though I could instead ask them to reduce the term, at no extra cost, which is clearly different from OP's situation.)
    – gidds
    Commented Apr 10 at 11:03
  • Also, remortgaging is common: fixed-rate deals apply only for a limited time (usually 2, 3, or 5 years), after which they revert to the lender's standard variable rate, and so it's common to get a new fixed-rate mortgage at that point.
    – gidds
    Commented Apr 10 at 11:03

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