What are Early Repayment Charges?
Early Repayment Charges or ERCs are financial penalties charged by your mortgage lender if you break their rules by repaying your loan, or part of it, earlier than agreed.
Generally speaking the ERC is linked to the term of your interest rate product.
- You take out a 2 year fixed rate mortgage. The ERC period is likely to be 2 years.
- You take out a 5 year tracker rate mortgage. Penalties apply during the 5 year period.
When you apply for a mortgage you will be agreeing to these terms which will differ depending on the mortgage interest rate you choose.
Occasionally there is a tie in period beyond the interest rate duration.
- You take out a 2 year fixed rate mortgage but the Early Repayment Charge period is 3 years.
In this last example you will need to stay on the lender’s reversion rate for one year otherwise ERC’s become payable.
When do Early Repayment Charges apply?
An ERC is payable when you repay all or part of your mortgage earlier than agreed when you applied for your mortgage.
There are many reasons or circumstances when this could happen:
Many mortgage deals allow you to make overpayments, to reduce your mortgage, without incurring repayment penalties (ERCs). Typically this is a maximum of 10% of your mortgage balance each year.
So if you have a mortgage of £150,000 you will be able to repay an extra £15,000 without penalty.
However, should you repay more than £15,000 in one year then the lender will levy ERCs on that extra amount and that could be a considerable sum.
YOU CHOOSE TO REPLACE THE MORTGAGE
If you deliberately incur early redemption charges it could be because of these reasons:
Due to either financial problems or personal issues you may need to sell your home and thereby repay all of the mortgage. This would be an unforeseen problem but the lender will still charge a penalty if you repay before the ERC period has ended.
REMORTGAGING TOO EARLY
Remortgaging is when you apply for a new mortgage, with a new lender, that then takes over your current loan. If this happens within an Early Repayment Charge period then fees will need to be paid to the old lender.
Why do lenders make these charges?
When you apply for a 5 year fixed rate mortgage your lender is expecting you to stay with them for the 5 years and they build this into their financial plans.
Effectively the tie-in period allows them to offer attractive rates of interest as the majority of borrowers will stay with them.
Should you remortgage away from them after 3 years they have missed out on the last 2 years worth of interest repayments and an interest penalty is charged as compensation.
How much are Early Repayment Charges?
Early Repayment Charges are normally expressed as a percentage of the mortgage amount affected by the fees. So the actual amount payable varies with the size of the mortgage repayment.
Let’s say that you had a £200,000 fixed rate mortgage with a 2% ERC. If you fully repaid your mortgage earlier than agreed you would be charged £4,000.
Remember that the fees only apply to the amount repaid. So if we take the same mortgage above but only repay £100,000 the ERC payable is £2,000. (2% of £100,000).
How ERC’s are charged during the rate period differs between lenders and will be shown in your mortgage illustration (quotation).
5 YEAR FIXED RATE
Year 1 – 5%
Year 2 – 4%
Year 3 – 3%
Year 4 – 2%
Year 1 – 1%
3 YEAR DISCOUNTED VARIABLE RATE
Year 1 – 2%
Year 2 – 2%
Year 3 – 2%
Can I get a mortgage without an Early Repayment Charge?
Both variable and tracker mortgages are affected by interest rate changes, up or down. So you must be happy that you can afford any changes to the monthly payments if this happens.
How do Early Repayment Charges affect overpayments?
ERC’s can be levied on overpayments if you repay too much in any one year. Most lenders allow 10% as an overpayment amount, if you go over this then early repayment fees will be incurred.
You have a £200,000 mortgage that allows 10% overpayments with a 5% ERC.
If you repaid £20,000, in addition to your normal payments, then no ERC is payable. You have used all of the 10% allowance.
However, the situation is different if you repaid £30,000 extra. You have exceeded the allowance by £10,000. The penalties will be:
£30,000 – Actual repayment amount
-£20,000 – Less the allowance
£10,000 – The excess is charged at 5%, so you need to pay £500.
How do I avoid paying Early Repayment Charges?
There is no way to get around the lenders ERCs, they form part of your mortgage contract.
However, there are some strategies that can help:
CHOOSE A RATE WITHOUT AN ERC
Sounds simple enough. If you know that during the next 1-2 years you will either be substantially reducing your mortgage balance, or moving the loan elsewhere, then an ERC free mortgage will prevent penalties being incurred. Typically this means choosing the SVR or a lifetime tracker rate.
Please ask your mortgage broker to check through the terms before you apply.
This includes paying off a lump sum or overpaying your mortgage. Most lenders allow 10% a year without penalty. So depending on how much you wish to pay off, do this in stages at the beginning of each new mortgage year and stay within the 10% rule each time. Remember to take into consideration any monthly overpayments you have also made.
If your ERC redemption penalties are substantial then it may be sensible to stay with your current lender when you move home. You should be able to port your mortgage, or transfer it, with the same lender over to the new property. You need to be able to satisfy the lenders financial checks as normal for this to happen. Your mortgage broker will be able to investigate your mortgage options.
SPLIT INTEREST RATES
This is some forward planning which is not available from all lenders.
If you know that in the near future you will be paying off a lump sum and you know either roughly or exactly how much that would be, then you may be to structure your mortgage as follows.
- AMOUNT LIKELY TO BE REPAID EARLY – Apply for a no ERC interest rate
- LONGER TERM MORTGAGE AMOUNT – Choose the best rate that suits your needs.
£50,000 – SVR with no ERC
£150,000 – 3 year fixed rate
£200,000 – Total mortgage
This structure will allow you to repay up to £50,000 straight away without an Early Repayment Charge.
What is a Mortgage Closure Fee?
Unrelated to Early Repayment Charges, lenders will often charge you for closing your mortgage account. This can be called a Mortgage Closure Fee, Deeds Release Fee or a Mortgage Exit Fee.
It is separate and in addition to any ERC’s. Typically costs between £100-£300.
A WORD OF CAUTION
Please make sure you seek appropriate advice regarding these fees BEFORE you make any mortgage applications, changes or repayments.
If ERCs are incurred the costs can run into thousands.
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