Do Overpayments Only Apply To The Principal

Get it right and overpaying your mortgage can be a huge cash boost, because...

You'll be eating into the debt you've built up from buying a home, meaning you pay it off quicker.
You don't pay interest on the amount you overpay.
The money you'd save on interest often beats the returns possible by putting it in savings, given savings rates are currently so pitiful.

Overpaying means you make the same gain as saving at your mortgage rate. If you've a 2% mortgage, you'd need savings paying at least this. And, if you've used up your personal savings allowance, you need savings paying even more; higher-rate taxpayers would need to earn 5% – impossible to get on any savings account now.

Here's a real-life example of someone who's saved big by overpaying their mortgage:

Started making overpayments on my mortgage seven years ago. Saved £18,600 in interest and paid up eight years and three months early. So my ex-mortgage payment can now go towards a fantastic retirement pot.
- Debbie

But before you chuck all your savings at your mortgage, you need to check the following...

Check 1: Can you overpay without penalty? Most can overpay 10% per year, but get it wrong and you risk £1,000s in fees

Most lenders allow you to pay 10% of your mortgage balance as an overpayment per year if you're still in your introductory fixed or discount period.

If you're on a tracker mortgage, or you're beyond that intro deal and paying your lender's standard variable rate (SVR), you can usually overpay by as much as you want. But many SVRs are expensive, so if on one it's best to check if you can save by remortgaging, rather than only overpaying.

However, the 10% rule is not universal. Some lenders punish those who try to overpay by more (see the What type of mortgage to choose guide for details).

Fees for paying too much are typically between 1% and 5% of the amount overpaid depending on your mortgage, though the fee you pay usually decreases the closer you are to the end of the fixed or discount period. The amount you pay as a penalty will vary between mortgage deals.

Say you've a five-year fix on a £100,000 mortgage and decide to overpay a lump sum two years into the deal. However, instead of sticking to the 10% (£10,000) limit free of penalty, you overpay £15,000 instead.

This means you must pay a 3% penalty on the extra £5,000 overpayment – £150. However, this 'percentage left on loan' rule of thumb is very rough, so always double-check with your lender.

The reason for such harsh penalties is because lenders want you to stick with them once the cheap rate ends and because they've also budgeted to earn a certain amount of interest from you during the mortgage deal, and overpaying means they'll get less.

Check 2: Do you have other, expensive debts? If so, clear those first

A crucial rule of debt repayments is: clear the most expensive debts first. Do so and the interest doesn't build up as quickly, saving you cash and giving you more chance of clearing debts earlier. Therefore, as a rule of thumb...

Clear high-interest credit cards and loans before overpaying your mortgage, as they're usually more expensive.

There are a few debts you probably shouldn't pay off before your overpaying your mortgage, including these....

Student loan debts

This specifically refers to official loans from the Student Loans Company.

Students who started university in 2011 or before, plus Northern Irish & Scottish students starting any time

For students who started university or college in 2011 or before, interest is set at the lower of base rate plus one percentage point, or the rate of inflation (RPI), making it the cheapest possible long-term debt. It's possible, if inflation is high and interest rates are low, you may have a mortgage that's cheaper than the student loan but over the long term, that's unlikely.

Plus, unless you're earning over a set threshold (the exact amount depends on whether you started before or after 1998) you won't have to make monthly loan repayments anyway. Due to the odd nature of these loans and how you repay them, you should prioritise your mortgage over repaying these.

Students who started university in 2012+ in England & Wales

For these students, interest is charged at the rate of inflation plus 3% while you're studying, then on a sliding scale from RPI to RPI+3% depending on how much you earn. So, for most students this applies to, it's actually likely that you'll pay a higher interest rate on your student loan that you will on your mortgage, at least at current rates.

However, that doesn't automatically mean that you should pay your loan off above overpaying your mortgage. Whether you should overpay your loan depends on whether you're likely to pay it all back before it's wiped in 30 years' time. Many won't, and if all your student loan overpayments are doing is depriving you of extra cash now, then it's not worth it.

For more information see Should I repay my student loans?
Credit card debt at 0%

It's arguable that those who are financially savvy, with top credit scores, strict organisation and timekeeping who disloyally shift from 0% credit deal to 0% deal (see the best balance transfers guide) should also pay their mortgage off before their credit cards, as even with balance transfer fees they're cheaper than most mortgages.

However, this strategy should only really be adopted by the extremely financially competent. For anyone who doesn't trust themselves to stay disciplined, it's generally best to clear card debts first, even at a short-term 0%

Check 3: Do you have a sufficient emergency fund?

I often say it's worthwhile having a cash emergency fund for those who are debt-free - apart from their mortgage (for people with expensive cards and loans debts I generally say you should Use Savings To Repay Debts?).

Yet, when you overpay most mortgages the cash is gone. So if you've an emergency (leaking roof or redundancy, not new shoes) and you'd overpaid with all spare cash, you could be forced to borrow again instead. Your earlier overpayments may not stop lenders charging you for being in arrears if you miss monthly repayments (see Mortgage Arrears Help).

So it's always a good idea to keep an emergency fund in a top savings account – I always say three to six months' worth of cash is a good guide, enough to live on if you lost your job, for example. If you're thinking of using newly arriving extra income (such as a pay rise) to overpay your mortgage, then build up an emergency fund first.

This applies even if the calculator shows you'd be better off overpaying your mortgage. It's what's known as 'a premium for liquidity'. In other words, it's sacrificing some interest for easy access to cash when needed.

The exception – mortgages with flexible features

Mortgages with flexible features (including offset, current account mortgages or those with a 'borrow-back' facility) allow you to overpay and borrow the money back. So you can overpay the mortgage, then withdraw cash without penalty if you need it again. If you have one of these, there's no problem putting all spare cash in the mortgage.

It can be used like a high-rate savings account as you're effectively saving at your mortgage rate but without paying tax. That said, as mentioned earlier, this is less beneficial as all savings accounts give you all the interest without tax taken off thanks to the new personal savings allowance.

This example shows how it can work:

On a £150,000, 25-year mortgage, offsetting £25,000 of savings could mean you pay off your mortgage one year and 10 months early, and save £3,350 in interest, while still having access to your savings if needed.

Don't misread this as saying everyone should go for one of these mortgages. The problem is their interest rates are usually higher than standard mortgages', and for many the extra cost of the mortgage debt more than outweighs the gain on savings.

But some of these flexible features are not well publicised so check with your lender if you have this option.

Check 4: Are your savings rates as high as possible?

Before you say"my interest rate is crap, so I'll overpay my mortgage", you need to check if you can boost the rate you're getting. I know it's hard at the moment with savings rates so low, but it's worth knowing this isn't a question of whether overpaying your mortgage beats your current savings. Instead, it must be "does repaying my mortgage beat thehighest-paying savings available?"

Many people earn pitiful rates, and assume they can't improve them. Yet better deals are often available. So if you haven't already, check the Top Savings Accounts and Top Cash ISA guides for all the best rates.

You needn't switch to them right now, as overpaying your mortgage may win out. But at least know what's on offer, and compare against that to calculate the right option.