How do mortgage overpayments work?
Q A few years ago we overpaid a lump sum of £5,000 with the aim of shortening our mortgage term. However, our lender reduced the monthly repayment, but not the duration of the mortgage. We are thinking of paying off another lump sum. Is it possible to insist on the length of the mortgage being reduced rather than the monthly repayment? And economically, is this the best thing to do? DS
A Paying off a lump sum from your mortgage reduces the size of the loan and so the amount of interest you pay each month. That is why your monthly payment went down. To reduce the mortgage term you need to increase the amount of capital you are repaying each month along with the mortgage
interest. If you have an interest-only mortgage – where the whole of your monthly payment is made up of mortgage interest – you can reduce the mortgage term only by arranging regular overpayments of capital alongside the interest payments.
With a repayment mortgage you can ask your lender to keep your monthly repayments at the same level they were before you made a lump-sum repayment. This will mean that more of your monthly payment will be made up of repaying capital, which will have the effect of shortening the mortgage term.
In the current climate it makes economic sense to overpay your mortgage because the interest you are paying on it is likely to be higher than the rate you could earn on saving.Source: www.theguardian.com