Mortgage overpayment: cutting the term saves more, but it's not always what it seems

Mortgage overpayment: lower payment or shorter term? The answer isn't that simple

With a €150,000 mortgage over 25 years at a fixed rate of 3%, the monthly payment is around €711 and total interest approaches €63,400. If a €10,000 extra payment is made toward principal in year 5, the choice between lowering the payment or shortening the term makes a difference of thousands of euros. The most commonly cited calculation shows that shortening the term saves about €7,700 in interest, compared with the €3,300 saved by lowering the payment. The difference grows the earlier you overpay, because interest in the early years weighs more in the total.

But the financial equivalence has a catch. Shortening the term and lowering the payment are equivalent operations as of today if the cash flows are discounted at the mortgage rate. The term advantage only materializes if the payment difference is reinvested or overpaid again month by month. In practice, that money usually ends up absorbed by everyday spending. Discipline, not math, is what tips the scales.

The real cost of the early repayment fee

Early repayment fees are capped by law, but they are not the same for everyone. On variable-rate mortgages, Law 5/2019 allows the bank to choose between a maximum of 0.15% during the first 5 years or 0.25% during the first 3, and zero thereafter. On fixed-rate mortgages, the cap is 2% during the first 10 years and 1.5% after that. Some banks charge less or waive it entirely. The fee is calculated on the amount repaid, so if the interest savings exceed that fee, the move still pays off.

Overpay or invest? The net comparison almost nobody does

With a fixed rate of 3%, some people consider buying bonds yielding 4-5%. The gross comparison is misleading: those bonds are taxed under savings income rules (19-23% in Spain), so a 4% gross yield leaves little more than 3% net. And if the bond is corporate, it adds credit risk. Overpaying a 3% mortgage is a guaranteed 3% saving, with no tax and no risk. The priority order that keeps coming up: first the emergency cushion, then overpaying, and only if there's money left over and you understand issuer risk, look at fixed income.

The emergency fund is untouchable with young children

With a young child at home, liquidity matters more than theoretical savings. The repeated recommendation is to keep an emergency fund of at least six months of expenses, and some prefer a year. Overpaying before having that cushion leaves the family finances exposed to surprises. The choice between payment and term also depends on discipline: if you're the kind of person who sets the difference aside month by month, lowering the payment and reinvesting is an option; if not, shortening the term is the choice for those who don't trust their own consistency.

What to request in writing before signing the overpayment

Before overpaying, it's worth asking the bank in writing for the updated amortization schedule for the option chosen, the exact fee that will apply, confirmation that the extra payment goes to principal and not interest, and the new maturity date if you shorten the term. Keeping that document is your backup against future discrepancies in the payment. The full calculation, broken down line by line, shows a surprising difference, but the fine print of the deed can eat into part of the savings.