How Mortgage Overpayments Work and How They Can Save You Thousands

Making overpayments on your mortgage can be one of the most effective ways to reduce the total interest you pay and clear your loan sooner. But the way overpayments work and the benefits you see depend on when you make them and how they are applied. As a mortgage broker I know all about them so let’s break it down.

Daily Interest Charges- Why Timing Matters

Most UK mortgage lenders calculate interest daily- this means your outstanding balance is assessed every day, and interest is charged on that day’s balance. This means that the sooner you make an overpayment, the sooner your daily balance drops and the less interest you’re charged from that day forward.

Let’s take an example:

Mortgage balance: £200,000

Interest rate: 5%

Daily interest: £200,000 × 5% ÷ 365 ≈ £27.40/day

If you make a £5,000 overpayment today, tomorrow’s interest is calculated on £195,000 instead saving you about £0.69/day immediately. Over a year, that’s roughly £250 in interest saved, even before considering the compounding effect.

Paying Early in the Term vs Later

Overpayments made early in your mortgage term have a much bigger impact than those made later. This is because in the early years, a larger proportion of your monthly payment goes towards interest rather than capital.

Let’s expand upon our example:

£200,000 mortgage, 25-year term, 5% interest

Overpay £5,000 in Year 1:

Interest saved over the life of the mortgage: approx. £7,432

Mortgage term shortened by approx. 1 year 4 months

Overpay £5,000 in Year 15:

Interest saved over the life of the mortgage: approx. £1,872

Mortgage term shortened by approx. 4 months

This means that the earlier you overpay the more impact in terms of interest charged and length of time in the mortgage.

What Happens After You Overpay: The Three Options

Lenders handle overpayments differently, and their default approach can significantly affect your outcome. Here are the three main scenarios:

Option 1: Keep the Term and Monthly Payment the Same (Default for some lenders)

Your overpayment reduces the balance, but your monthly payment stays the same. Because you’re now paying the same amount on a smaller balance, more of each payment goes towards capital, clearing the loan faster.

For Example:

Before overpayment: £200,000 balance, £1,169/month, 25 years left

After £5,000 overpayment: Still £1,169/month, but term reduces by approx.1 year 4 months

Interest saved: approx. £7,432

The implication of this is that you continue to overpay your mortgage each month without making any adjustment to your mortgage term or payment amount.

Option 2: Recalculate Monthly Payment

(Default for some lenders after a threshold payment amount or at annual review)

Your lender recalculates your monthly payment based on the reduced balance and the original term. This lowers your monthly outgoings but keeps the end date the same.

For Example:

Before overpayment: £200,000 balance, £1,169/month, 25 years left

After £5,000 overpayment: Payment drops to ~£1,139/month

Interest saved: Approx. £2,400

The implication of this is that you would have more monthly cashflow relative to option 1.

Option 3: Reduce the Mortgage Term

(Usually requires a lender appointment & affordability check)

You formally request your lender to shorten your term, keeping payments higher but ending the mortgage sooner.

For Example:

Before overpayment: £200,000 balance, £1,169/month, 25 years left

After £5,000 overpayment & term reduction: New term 23 years

Interest saved: Approx. £9,200

This has the implication of reducing interest charged, while maintaining or increasing monthly payments dependent on how much the term is reduced. Bear in mind that many lenders have a requirement that any new term is in whole years.

Overpayment allowances

If you’re on a fixed rate mortgage, most lenders let you make overpayments of up to 10% of your mortgage balance each year without charging a penalty.

• This year could be the calendar year (January–December) or your mortgage anniversary year (the 12 months from when your deal started).
• Some lenders base the 10% on your balance at the start of the year, others on your balance at the anniversary date.

If you pay more than your allowance, you may have to pay an Early Repayment Charge which is a percentage of the extra amount you’ve paid above the allowance (the amount can vary dependant on how far into your fixed rate you are).

It’s worth asking your lender:

• If you make an overpayment and keep your monthly payment and term the same, or
• If you make an overpayment and reduce your term,

if these count towards your 10% allowance. Some lenders don’t count these types of changes towards your allowance. If that’s the case, it can be a means to keep overpaying beyond the 10% limit without paying any penalties.

Overpayments when fixed rate deal is coming to an end

When your fixed rate mortgage deal ends, your lender will usually move you onto their Standard Variable Rate (SVR) by default, 

• On a SVR, you can normally overpay any amount without penalties
• Some lenders even let you wait until your fixed rate ends, make a big overpayment while on the SVR, and then choose a new deal with them.
• In some cases, they can backdate the new deal so it’s as if you were never on the SVR at all, meaning you get the benefit of the overpayment without losing out on a lower fixed rate.

This can be a useful way to pay down a chunk of your mortgage without triggering Early Repayment Charges, especially if you’ve got savings or a lump sum ready to use.

Key Takeaways

• Daily interest calculation impact payments
• Paying earlier in the term rather than later can save on interest
• There can be up to 3 options following an overpayment: Keep the Term and Monthly Payment the Same, Recalculate Monthly Payment and Reduce the Mortgage Term all of which have different implications
• Most lenders have overpayment allowances on fixed rate products
• Some lenders will allow you to overpay without penalty on SVR and then backdate a new product, so it was as if you was never on SVR