Paying part of the mortgage before remortgaging

Question

I am aware the exact answers to my questions below may depend on the conditions of the mortgage but I would still be grateful for some advice and pointers.

Let's say I took a 2-year fixed rate mortgage for £100k. At the end of the initial 2-yr period, I have paid £20k towards the mortgage. £5k of this went to interest, and £15k towards the principal amount. So at the end of my 2-year period, I stand with a debt of 100k-15k = £85k, and in a position to be able to remortgage.

Let's also assume that in the initial 2-yr period I have accumulated £10k in the bank, which I could have used to gradually overpay the mortgage without an overpayment penalty. My questions are:

1. If I am remortgaging, can I use my £10k savings to reduce the mortgage amount to 85k-10k=£75k (directly deducting from the principal amount) before taking a mortgage with another provider?

2. If the answer to the first question is 'Yes', I believe this is definitely preferable to having overpaid, since through overpayments a massive chunk of my £10k would have gone to pay off interest rather than the principal amount. In contrast, by paying off £10k directly on the principal amount before remortgaging, I ensure that all the money is used to reduce the principal amount.

I hope the question is clear, basically if I have extra money and I want to minimise paying off interest, and can remortgage, what would be the most sensible course of action?

Answer 1

The answer to question 1 is yes, you can always reduce your loan when you remortgage by introducing additional funds. There is some possibility a (relatively) small charge might be applicable for managing the marginally more complex transfer, but it shouldn't be too much..

The answer to question 2 is NONE of your over payment amounts would have gone on interest, but you MIGHT incur penalty charges.

Interest is only charged on the outstanding loan amount (i.e. £100K initially, reducing to £85K over 2 years in your example) at the interest rate determined by your mortgage agreement - there is no 'paying off interest' as such.

Over payments are essentially all capital payments, reducing the principal/loan amount, so no additional interest would be paid if you opted for over payments.

If you used your £10K to made the over payments throughout the 2 year fixed period you would in fact have paid LESS interest by the end of the 2 years, because you would be reducing the loan amount at a quicker rate, and thus the interest you pay each month (based on the lower outstanding loan at that time) would be lower. BUT... over payments might have attracted over payment penalties (typically a percentage of the amount you pay) and these penalties often mean it's not worth doing. Most fixed term mortgages have such penalties, but it depends on the agreement, and many mortgages also allow you to make over payments up to a certain amount each year before you get hit.

Edit (additional suggestion):

If the example you provide is one based on what you expect might happen to you over the next couple of years, something you could CONSIDER is an offset mortgage. Here your £10K that you accumulate reduces your interest through the 2 years, but you keep it in savings where you can access it if you need to. Accessing it will then cause a corresponding rise in interest payments, but to no higher level than you would have been paying if you had nothing in the savings in the first place. You usually pay a slightly higher interest rate for these sort of mortgage, so it's impossible to know if it would be more economical, and how appropriate it would be for you in other respects depends on many factors.