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Should I overpay my mortgage monthly or with a lump sum at the end of each year?

I have a five-year fixed-rate deal, just missed the rising interest rates and want to plan for an uncertain future.

Q I took a five-year fixed-rate mortgage last summer and was lucky enough to just miss the rising interest rates. I’m looking ahead, as things could still be tricky in five years, and so I plan to overpay as much as I can. Does it make a difference how I overpay? Would it benefit me more to make a monthly payment or a larger lump sum at the end of each year?

A If you had said “larger lump sum at the start of each year”, I’d have said lump sum every time. But if the choice is between chipping away at your outstanding mortgage by making monthly overpayments – which reduces the amount of interest you pay – and waiting until the end of the year to bring down your mortgage balance, I would say monthly overpayments would be more beneficial. But both answers assume that you don’t incur penalty charges by overpaying too much.

So before you set up overpayments on your mortgage, you need to ask your lender what your annual overpayment allowance is. This is the amount you can overpay each year without incurring any early repayment charges. With fixed-rate mortgages this is typically 10% of the mortgage loan, although a handful of lenders let you overpay up to 20%.

You also need to look closely at the detail to avoid going over your lender’s limit. At Nationwide building society, for example, the limit is 10% a year of the original loan amount (for all mortgage products reserved on or after 29 May 2013, except for standard mortgage rate and base rate mortgages where no limits apply). So the amount you can overpay remains the same for the whole of the mortgage term.

At HSBC, Santander and Yorkshire building society, however, the 10% limit is applied to the outstanding balance each year, so the amount you can overpay goes down. At HSBC, the year’s limit is reset annually, either on the date your mortgage account was opened or the date you switched to a fixed rate. At Santander the limit applies to a calendar year, so it is reset on 1 January.

The other thing you need to make clear to your lender is that you want your overpayments to have the effect of reducing your mortgage term rather than reducing your monthly payment.

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