Does it make sense to overpay the mortgage and accept a penalty?

Hi there.

My friend bought a £300k UK property last year and took out a £185k, 21 year mortgage. The mortgage is 3.11% for five years, then rises to 5.35%. If this seems high, it's because she is an expat. Her plan is to return to the UK and the house is where she will live. 
The mortgage payments are just under £1k a month and after five years, she will have paid almost £60k, yet the mortgage amount will only have dropped to about £150k. So £60k paid, £25k of which is interest. 

My friend has £40k in premium bonds paying a paltry 1%, in effect 0.8% because of the jackpot prizes so I hear. Next year she will receive a lump sum of around £120k and would be in a position to pay it off in full. This would activate a penalty clause for overpayment which requires a payment of 5% of the total borrowed; this is just over £9k. 

Having read of the benefits of overpaying a mortgage, would my friend be best to pay a lump sum of £30k immediately and keep £10k in PB as an emergency fund? Then pay it off in full next year on receipt of the lump sum? Even with the penalty of just over £9k, it seems to me that my friend will pay a lot less interest overall and will have the benefit of being mortgage free. 

What do the wise heads think?


  • Swoosh84
    Swoosh84 Posts: 166
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    edited 12 April 2021 at 8:13AM
    £9k is alot, not worth it imo but depends on their max yearly overpayment allowance, they can pay it off in full at the end of the fixed period. Max out premium bonds, find another decent interest paying account for the rest of the cash.

    Your friends provider will allow an overpayment penalty free each year. my provider allows payment of up to 10% of the balance at the start of the year. So I would pay this 10% in full every year and then at the end of the fixed rate period pay the full balance penalty free.

  • I agree that just over £9k is not a trifling amount, but isn't the idea that the sooner you pay off the mortgage, the less interest you pay overall? By stretching out payments for at least five years to avoid paying the £9k, aren't you cutting your nose off to spite your face? You would end up paying significantly more than £9k in interest.

    Regarding the terms, it says that up to 50% of the loan fee can be paid off in the first five years with no penalty charge.
  • Thrugelmir
    Thrugelmir Posts: 89,546
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    Pay up to the annual overpayment limit. When the 5 year fixed term ends then reduce the mortgage once it is penalty free. 
  • Swoosh84
    Swoosh84 Posts: 166
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    edited 12 April 2021 at 1:34PM
    So you can pay 50% off, assume this is a total of 50%, 10% per year?

    Think everyone will agree that its best to pay off mortgage in most situations to save interest, but there are slower approaches to take that will save money in the long run.

    Do some further calculations which takes into account that you can pay off a fixed percentage of the balance each year penalty free. In year one, they should have been able to make overpayments of £18.5k. This would have significantly reduced the 25k interest alone for the first 5 years. Also take into account that this 10% payment can be made every year.

    Not saying its not beneficial to do the full payment, just saying you need to factor in other elements.


  • Thanks for the replies. I'm waiting for clarification as to whether 50% in five years actually means 10% per year, or if it means a 50% lump sum in one go is also possible. From documents I've seen, it appears to be 50% in five years whenever, not restricted to just 10% per year.
  • It appears that the mortgage lender does allow up to 50% of the total loan amount to be paid off at any time within the first five years. So my friend would be best to pay the £30k lump sum in immediately and then overpay every month by as much as she can afford until reaching the 50% amount, right? The mortgage will be vastly reduced and by the end of five years can be paid off in full without any penalty.
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