Is Making Extra Loan or Mortgage Payments Worth It?

Some borrowers like to make additional payments on their loans. In the right circumstances, saving on interest and clearing debt sooner is a smart move. However, overpayment for your mortgage or loan isn’t the right choice for everybody. 

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Let’s take a look at the pros and cons of overpaying loans to see if it could work for you.

How Loan and Mortgage Repayments and Overpayments Work

To understand overpayments, it’s essential to think about how mortgage repayments function.

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Let’s establish the difference between paying down the loan principal and paying down debt. 

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• Paying down the principal means reducing the original loan amount. This lowers the amount you still owe on the loan.
• Paying down debt includes paying both the principal and the interest. Standard monthly payments typically cover both.

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Overpayments involve paying more than your standard monthly payment. Generally, these extra funds go towards reducing the principal. So, when you overpay, these payments lower your outstanding balance and mean future interest is calculated on a smaller amount, which can save you money over time.

Overpayment Calculator: Will You Save Money?

Before you consider overpayment, you need to be sure it will save you money in the long run. Here’s how you can make the calculation manually, or use our handy calculator below.

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Use a Mortgage Overpayment Calculator tool to model scenarios based on your loan amount, interest rate, and repayment term.

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For example, let’s say you have a £150,000 mortgage with a 4% interest rate over 20 years. Making a one-off £10,000 payment could save you £11,402 in interest and reduce your loan term by nearly two years.

However, any savings you make depend on the loan’s interest rate, term, and how early overpayments are made. Overpaying earlier in the loan term has the most impact because your principal balance and interest are at their highest at the start of your loan.

Potential Pitfalls: Overpayment Penalties and Other Costs

There are some downsides to overpayment, even in scenarios where you calculate savings. 

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• Some lenders apply Early Repayment Charges (ERCs) of 1% to 5% of the overpaid amount.
• Overpayments tie up cash that you might need for emergencies or investments.
• Some lenders charge admin fees to process overpayments.

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When Overpaying on a Loan or Mortgage is a Smart Move

Despite the potential downsides, there are several scenarios where overpayments make total sense:

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• If you’re stuck with a high interest rate, overpayments can reduce the overall cost of your loan.
• If your lender supports penalty-free payments or the potential savings that outweigh any fees involved.
• If the overpayment won’t involve cutting into emergency funds, investments, or your pension. 

When Overpayment Might Not Be the Best Option

Overpayment might not be for you in the following situations:

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• If a high ERC negates the potential savings you’ll get from the reduced interest.
• If you have other loans with higher interest rates, you should reduce first.
• If overpaying, your loan eats into your emergency funds.
• If you could unlock greater returns through investments.

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Alternative Ways to Manage Debt Without Overpaying

As you can see above, overpayments aren’t always the best option. Here are a few alternative methods to manage your debts.

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Remortgage for lower rates: Where possible, switching to a cheaper deal can reduce monthly payments and overall costs.

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Offset mortgages: Look into offset mortgages, which link your savings account to your loan. For example, if you have a £150,000 mortgage and £50,000 in your savings account, you only pay interest on £100,000.

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Flexible mortgage options: Some lenders allow you to make occasional overpayments without incurring a penalty.

Make Sure The Juice is Worth the Squeeze

Making extra payments on your loan or mortgage can save you money. However, there are lots of other factors to consider. Always check for overpayment fees, ensure that you have emergency funds, and consider whether savings or investments are the best way to help you unlock your financial goals. 

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Ultimately, everyone's situation is unique. By evaluating your financial priorities and understanding how overpayments work, you can make an informed decision that benefits your long-term financial health.

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