The world has experienced several major historical events in recent years, including a global pandemic and the war in Ukraine. As a result of this turmoil, inflation rose sharply, reaching a high of 11.1% in October 2022.
In response, the Bank of England (BoE) raised their base rate 14 consecutive times, in an attempt to control inflation.
While the rate of inflation has fallen – the Office for National Statistics (ONS) reports that it was 6.7% in the 12 months to September 2023 – rising interest rates caused an increase in mortgage costs for many people.
Indeed, Sky News reports that more than 5 million households could see their annual mortgage payment rise by an average of £5,100 by the end of 2024.
You may have already seen an increase in your monthly payments if you are on a tracker or standard variable rate (SVR) mortgage. Those with fixed-rate mortgages will likely see a sharp increase in costs in the near future when those deals come to an end.
If you can comfortably afford your monthly repayments at the moment, you may be thinking about overpaying your mortgage. This could potentially reduce your overall interest costs and help you pay off the loan earlier.
Conversely, you might be considering investing any extra money instead, with the hope that you will accumulate more wealth over time. You could potentially use these funds to pay off your mortgage later, or help you achieve other long-term goals.
Read on to learn more about the pros and cons of overpaying your mortgage or investing surplus funds.
Overpaying your mortgage could save you money in the future
Your monthly mortgage payment is typically calculated based on three things – the amount you borrowed, the interest rate, and the term of the loan.
By overpaying your mortgage with a lump sum or increasing your monthly payments, you may be able to clear the balance faster and reduce the term of the loan. This will likely save you a significant amount in the long term.
Overpaying could be particularly beneficial when interest rates are rising because, if you can pay off your mortgage faster, you reduce the amount of interest you pay.
Figures from NatWest demonstrate the significant difference that regular overpayments could make.
If you had a £250,000 mortgage with a 4% interest rate, being paid off on a capital and interest basis over a 30-year period, your monthly payment would be £1,194.
However, if you overpaid by £200 a month, you could potentially reduce the term of the mortgage by seven years and two months. This means you would save an estimated £48,060 in interest payments.
You will also benefit from the increased equity your overpayments have generated. This can have an emotional benefits as you owe less and own more of your home.
Additionally, paying off the loan faster could make it easier to secure a better interest rate if you remortgage because you reduce your loan-to-value (LTV) ratio. Typically, lenders take your LTV into account when calculating the interest rate they will offer you.
If you are thinking about making overpayments to a buy-to-let mortgage, you may also need to consider other factors such as your Capital Gains Tax (CGT) position if you sell the property. Seeking expert advice can help you decide whether overpaying is beneficial for you or not in this situation.
Paying off your mortgage frees up wealth for other uses
Paying off your mortgage faster usually means you pay less interest overall, and it also frees up wealth that you can use elsewhere. Once you no longer have a mortgage payment, you could invest that money into your pension or savings each month instead.
Regardless of how you decide to use it, having those additional funds could make it easier to reach your financial goals and achieve your desired lifestyle. This is especially beneficial as you approach retirement because your income could reduce when you stop working.
Being mortgage-free also has an emotional benefit. Indeed, in their 2023 Life Well Spent report, SunLife found that 85% of over-50s said they felt happier after paying off all their debts. Having this peace of mind could be incredibly valuable in your later years.
The money may be better spent elsewhere
While overpaying your mortgage can be beneficial, you may want to consider whether you could use these surplus funds more effectively.
For example, if you have other high interest debts, such as credit cards, it may be sensible to pay these off first. This could give you even more additional funds to contribute to overpaying your mortgage.
Additionally, consider whether you have enough emergency savings to deal with unexpected costs such as expensive home repairs or replacing your car, for example. Using the extra funds to top up your emergency savings could make you more resilient against financial shocks in the future, so they don’t disrupt your long-term plan.
Investing the funds could help you grow your wealth
You may be considering investing surplus income instead of overpaying your mortgage. When deciding which option is right for you, it may be useful to consider your attitude to risk.
Investing in the stock market means some level of risk. The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Conversely, if you overpay your mortgage, you are likely to save money in the long term by reducing the interest you pay.
That said, stock markets typically bounce back after short-term market fluctuations, so if you hold investments over a long period, you may be able to achieve meaningful growth.
Using our earlier example of a £200 monthly overpayment on your mortgage, let’s consider what could happen if you invested that money instead.
Figures from Aviva show that if you invested £200 a month your initial investment would be £72,000 after 30 years.
Assuming annual fees of 0.75% and a growth rate of 4.5% – their estimate for a medium-risk investment portfolio – you would see growth of £58,968 giving you a total investment value of £130,968.
While these are only estimates and there are no guarantees of positive returns, this demonstrates the potential benefits of investing instead of overpaying your mortgage.
It’s important to consider your own financial plan
There is no simple answer as to whether it is sensible to overpay your mortgage or use those funds elsewhere. Ultimately, it depends on your own personal circumstances and your financial plan.
If you are close to retirement, for example, you may prioritise clearing your mortgage so you can be debt-free and reduce your outgoings in your later years.
On the other hand, if you still have decades before you retire and start drawing from your savings, you could benefit from investing the funds instead as you have more time for them to potentially grow.
That’s why it is important to review your financial plan and see how overpaying your mortgage could affect your long-term goals before making any decisions.
Get in touch
If you want to explore the potential benefits of overpaying your mortgage or investing your wealth, we can help.
Email hello@fcadvice.co.uk or call 0330 828 4714.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
Think carefully before securing other debts against your home.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term (minimum of 5 years) and should fit in with your overall risk profile and financial circumstances.
