If you’re in a position to make an overpayment on your mortgage to reduce the amount you owe or you’ve found a better deal with a lower interest rate and want to switch to that one, it makes financial sense to do so. Likewise, if you can repay your mortgage early, you’ll no longer be in debt and you’ll own your property outright.
So what might make you think twice about doing any of these? An early repayment charge. Applied by your lender in some circumstances, this can be extremely costly. So much so that it may negate any financial benefits you stand to gain by switching, overpaying or repaying your mortgage early. But what is an early repayment charge, how much is it and is there any way to avoid it?
What is an early repayment charge?
An early repayment charge (ERC) is a fee that’s applied by your lender in certain situations. When you take out a mortgage, you agree to a mortgage term. This is the entire lifespan of your mortgage, such as 25 years. You also usually have a tie-in period at the start of your mortgage. This can run on for longer than your chosen mortgage deal, as explained below. Lenders’ terms regarding ERCs vary. However, this fee usually applies if you either switch to a new deal before the tie-in period has ended, make a higher overpayment than is allowed under your mortgage terms or repay your mortgage early.
Switching to a new deal
As an example, for your new home in Bexleyheath, you may have arranged a fixed, discounted or capped rate for 2 years for your mortgage. Your lender’s terms may state that an ERC applies if you remortgage within 3 years. This means that you’ll have to pay the lender’s standard variable rate (SVR) for a year after your deal has ended. The SVR will be a much higher rate than you’ve already been paying. So how can you avoid paying the SVR? You can switch to a new deal when your current one ends and just pay the early repayment charge. However, ERCs are expensive and it may cost you too much to make switching to another deal worthwhile. If you want to switch to a new deal, our mortgage brokers can check whether you’re liable for an ERC. And, if so, how much this will cost you.
Making overpayments
Most lenders allow you to make overpayments of up to 10% each year. However, if you overpay by more than this without prior consent from your lender, you’ll be penalised with an ERC. Depending on the terms of your mortgage, you might also not be allowed to make overpayments during the tie-in period. If you do make an overpayment during this time, an ERC will become payable.
Repaying your mortgage early
Circumstances change and you may have benefitted from some money that you can use to pay off your mortgage early. Or you may have no choice but to repay your mortgage early. For example, you may have joint ownership of a home in Pimlico but have split up with your partner and need to sell the property. If your mortgage is repaid at a time when your lender’s ERC applies, you could end up paying a lot more than you’d otherwise need to.
Porting your mortgage
Porting your mortgage is when you take your existing mortgage deal with you when you move. Although porting your mortgage can be a good way to avoid having to pay an ERC, some lenders do apply this charge in some cases. This is usually when there’s a delay between the purchase of your new property and the sale of your current one. However, if everything goes through within a set period, such as 180 days, the lender should refund the ERC. Another reason a lender may apply an ERC is if you only port some of your existing mortgage. This is called a partial port. In this case, your lender may apply the charge to the part of your mortgage that you don’t transfer to your new property.
Why do lenders have early repayment charges?
When you arrange your mortgage over a specific term and possibly have an introductory period, the lender expects you to retain the funds and pay the agreed interest rate for that term. As well as the costs involved if you repay some or all of your mortgage loan early, the lender will lose the interest that they should make on your loan over that term. An ERC, therefore, is a way for your lender to recoup some of their costs and lost interest payments.
How much is an early repayment charge?
An early repayment charge is generally calculated as a percentage of your outstanding loan amount, ranging between 1% and 5%. This amount may be lowered over time. For example, if you have a fixed-rate deal for 5 years, you may be charged 5% if you switch to a new deal within the first year. If you did this in the second year, the charge may reduce to 4%. And so on, with the charge being calculated at 1% if you leave the deal in the fifth year.
In some cases, the percentage might not be calculated on the outstanding loan amount. For example, if you’re allowed to overpay your mortgage by 10% each year but you make a bigger overpayment, the early repayment charge may be calculated on the amount you’ve paid above your 10% allowance.
To decide whether it’s worth paying the early repayment charge, you need to check what your lender’s terms are. If your outstanding loan balance is fairly small and the ERC percentage is low, you may save more money by paying the ERC than you would if you paid the interest for the remainder of your mortgage term.
What if you don’t agree with an early repayment charge?
If you’ve had to pay an ERC and feel that you’ve been unfairly charged, you need to contact your lender. You need to discuss your complaint with them and give them the chance to respond. Usually, depending on the complaint, they have to give you an answer within 8 weeks. If you still have an issue with the early repayment charge and the response you’ve received from your lender, you can take the matter further via the Financial Ombudsman Service.
How to avoid early repayment charges
There are various ways to avoid early repayment charges:
- Make sure that you don’t exceed your overpayment allowance each year.
- Port your mortgage when moving home so that you remain with your current lender.
- Choose a mortgage that doesn’t come with early repayment charges.
- Check with your lender when they’ll allow you to switch to a new lender without having to pay an ERC.
- Be sure to arrange a new deal with your existing lender to start when your current deal ends. That way, you won’t have to pay their standard variable rate or an ERC.
Find out if you’re liable for an early repayment charge
Our mortgage lenders check for details of early repayment charges when looking at mortgage products. They will advise you if an ERC is applied by your lender for the deal you’re looking at and under what circumstances. They’ll also ensure that you’re aware of the amount and any tie-in period before you proceed with a mortgage deal.
Details of an early repayment charge should be included in the terms of your mortgage agreement by the lender. You can refer to this at any point if you’re considering switching to a new deal, making an overpayment or repaying your mortgage early. If you can’t decide what’s best financially, give our mortgage brokers a call on 01322 907 000. They’ll take a look at your existing mortgage product and the ERC and compare it with the option you’re considering. This will help you to weigh up the pros and cons of leaving your mortgage as it is, remortgaging or paying off some or all of your mortgage balance.