Early repayment charges aren't as scary as you think
Paying off your mortgage faster will get you one step closer to financial independence. However, some homeowners are hesitant around making mortgage overpayments due to fear of getting hit with an early repayment charge. As long as you understand what these are and when they are applied by the lender, you should be well placed to avoid them. In this article, we provide you with our tips on how you can still be smart and pay off your mortgage without getting unexpected early repayment charges (ERC) from your lender.
What is an early repayment charge?
An early repayment charge is a penalty applied by the lender if you repay more on your mortgage than the permitted amount during your tie-in period. Early repayment charges are typically found on fixed and discounted variable rate mortgages. Whether you do, and the amount you get charged, really depends on the terms and conditions associated with the mortgage product you selected. The mortgage offer document will outline the early repayment restrictions. Typically this ranges from 1% to 5% of the amount you overpay. There can also be additional charges if you completely pay off your mortgage.
Why do lenders charge ERCs?
Lenders lend you money and charge you interest to make a profit. So when you end a mortgage early, they don’t earn as much from you as they expect to. ERCs are in place to deter consumers from paying off their mortgage early. There are also costs that the lender incurs in sourcing the money which is subsequently lent to you, so the charges also act as compensation to cover those costs.
When are ERCs applied?
● Significant repayment – making a sizeable overpayment on your mortgage that breaches the threshold outlined in your mortgage offer document would result in your lender applying an ERC penalty.
● Move home – if you are moving house, you may have to switch lenders. If you are part way through your initial deal period for your fixed or discounted deal then you are likely to be charged an ERC penalty.
● Switch mortgage deals early – you may decide that you want to move to a different mortgage product within the same lender or different lender whilst you are in your deal period. If that is the case you are likely to be subject to ERC.
● Pay off your mortgage – perhaps you’re approaching retirement and want to use your savings to pay off your mortgage or maybe you have received some inheritance. By paying the entire outstanding balance of your mortgage, you may be subject to large ERC penalties.
Does it ever make financial sense to pay an ERC?
You could be better off paying the lender an ERC if the benefits of re-mortgaging to a better deal outweigh the amount you have to pay. These situations are rare, so it is important you do the maths before making any decisions. Here are some examples where this may happen:
Found a better deal – if you have found another mortgage deal that you are eligible for which is better than the one you are currently on, even after paying ERCs. For example, mobile-only lender Atom Bank provided the cheapest ever 5 year fixed deal at just 1.29%.
Home value has significantly increased – if your home value has gone up significantly and you’re now in a lower loan to value band (LTV), then this could justify paying an ERC. LTV is the amount of equity you hold in your property compared to the loan value and is what lenders use to determine what deal you are eligible for. The lower your LTV within a certain threshold, the better deals you can get access to. You can expect to get better deals if you fall below one of these typical thresholds - 90%, 85%, 80%, 75% and 60%. Again, it’s important to do the maths before switching products early.
How to avoid paying an ERC penalty?
Choose a deal with no ERC – there are lenders who offer flexible products which allow you to overpay without limit. If you are approaching the end of your deal and plan to overpay more than 10% of your loan in a single year, then it makes sense to select such a product.
Port your mortgage - if you are moving home, your lender may let you 'port' your mortgage deal even if you are borrowing more money. This would mean the same deal at the same interest rate would now apply to the mortgage on your new property.
Pay up to the limit – as mentioned previously mortgage deals often have a limit at which you are allowed to pay up to without any penalties. They are typically 10% of the loan value every year but, depending on the lender, this can start from the anniversary of when you took out the loan or it can start from the beginning of the calendar year. Some products may allow less and some not at all. Best practice is to read the mortgage offer document or call your lenders mortgage team to confirm. It is also important that, if you are aggressively paying off your mortgage, you keep track of the total amount paid. Whilst 10% may not sound like a lot, for the majority of people, it’s more than enough allowance to overpay without compromising their lifestyle.
Wait until your mortgage deal ends – once you go onto standard variable rate (SVR), there is typically no limit on how much you can overpay. However, SVR rates are often very expensive so please take this into consideration if you are not planning on paying off your entire mortgage. Even before doing this, it is worth checking with your lender or reviewing your mortgage offer document to confirm when your ERC period ends.