What are early repayment charges and how to avoid them
Paying off your existing mortgage deal could be a great goal to work towards to help you reach financial independence. However, you may face early repayment charges from mortgage providers which could cost you thousands of pounds. 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 mortgage lender if you repay more on your current mortgage than the permitted amount during your tie-in period. Early repayment charges are typically found on fixed rate interest and discounted variable interest rate mortgages. Whether you do, and the amount you get charged on your early repayment really depends on the terms and conditions associated with the mortgage product you selected and the current deal you are on.
The mortgage offer document will outline the early repayment restrictions, typically ranging from 1% to 5% of the amount you overpay.
There can also be additional charges if you completely pay off your mortgage balance, so fully understand all the details and ask yourself if it is worth paying.
Why do lenders charge early repayment charges (ERC)?
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 mortgage broker 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?
Making a sizeable overpayment on your mortgage that breaches the threshold outlined in your mortgage offer document or contract would result in your lender applying an ERC penalty - whether its a lump sum or recurring monthly payment.
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 from your current mortgage to a new mortgage deal within the same lender or different lender whilst you are in your deal period because of a lower interest rate. If that is the case you are likely to be subject to ERC.
Pay off your mortgage –
Perhaps you are 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 early repayment charge?
Whether or not you should pay a mortgage early repayment charge depends on your circumstances. 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 of the common reasons why this may happen:
Found a better deal
If you have found another new mortgage (cheaper deal for example) from your current or new lender that you are eligible for, even after paying ERCs. For example, mobile-only lender Atom Bank provided the cheapest ever 5 year fixed rate mortgages at an interest rate of just 1.29%.
Home value has significantly increased
If your home value has gone up significantly and you are 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 new deal you are eligible for.
The lower your LTV within a certain threshold, the better deals you can get access to. For example, 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 mortgage products which allow you to overpay without limit and additional fee. If you are approaching the end of your current 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 bank 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. If you are aggressively paying off your mortgage early, you keep track of the total amount paid off your mortgage balance. 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 - you may want to avoid paying for a certain period. Even before doing this, it is worth checking with your lender or reviewing your mortgage offer document to confirm when your ERC period ends.
If you are unsure about any aspect of your mortgage, it's a good idea to seek guidance from an expert. By taking the time to understand early repayment charges and how to avoid them, you can make more informed decisions and potentially save thousands of pounds in fees over the life of your mortgage.