Everything You Need to Know About Mortgage Early Repayment Charges

Posted 19 November 2018 by Nick Parkhouse

If you have a fixed or tracker rate mortgage it may come with early repayment charges. Here’s how they work...

If you’re thinking of taking out a fixed, tracker or discounted-rate mortgage deal, then there is a strong chance that the deal you choose will come with ‘early repayment charges’.

Previously known as ‘redemption penalties’ or ‘early redemption penalties’, these charges can run into thousands of pounds if you pay off part or all of your mortgage early. So, what are early repayment charges? Why do lenders charge them? And how do you avoid paying them? Keep reading for answers to these questions and more.

What are early repayment charges?

If you take a special mortgage deal from a lender, the chances are that it will come with ‘early repayment charges’ (ERCs).

ERCs form part of your mortgage contract and they are a fee that you pay if you repay part or all of your mortgage within a specified period of time.

For example, if you take a two-year fixed rate then you will typically pay ERCs if you were to repay your mortgage within that two-year period.

Why do lenders charge ERCs?

Banks and building societies fund the cost of mortgages in different ways. Some lend against the deposits lodged by savers and investors, while others borrow money on the money markets which they then lend in the form of mortgages and loans.

When your lender has borrowed a tranche of money on the money markets they expect you to keep your mortgage for a certain amount of time. So, if you end the mortgage early, they won’t get that expected money back. To recoup those initial borrowing costs and to compensate for the money they would lose, your lender levies an early repayment charge.

Similarly, if you take out a discounted rate your lender may offer a special product on the basis that it will be able to fund this discount by ensuring you remain on their standard rate for a period after the discount has finished. If you pay off the mortgage early, the lender may again incur a cost.

When might I pay an early repayment charge?

There are several situations in which you might pay an early repayment charge:

  • You pay off your mortgage before the end of your fixed, discounted or tracker rate, for example by selling your home, remortgaging to another lender, or by using a lump sum.
  • You sell your home and you want to take out mortgage on another property with a different lender.
  • You pay off a large part of your mortgage during your initial rate period.
  • You switch to another product with the same lender before your deal ends.
  • You move home and there is a delay between selling your old property and completing on the new purchase (see below).

How are early repayment charges worked out?

Each lender has a different way of calculating the early repayment charge that you pay.

If you take out a fixed-rate deal, your ERCs will normally amount to a percentage of the amount that you repay during the fixed-rate period. For example, you might pay an ERC of 3% of the amount you repay during the fixed rate.

Some lenders apply decreasing charges. For example, if you take out a fixed-rate deal you may pay ERCs of 5% in the first year, 4% in the second, 3% in the third, 2% in the fourth and 1% in the fifth year.

If you take out a discounted rate, then the ERC may be based on a fixed amount of interest. For example, you might pay 2 or 3 months’ interest if you come out of a discounted or tracker rate early.

Check the small print of any special deal to establish what early repayment charges apply.

Do I always have to pay them?

No. There are certain situations where you won’t have to pay an early repayment charge. These include:

  • If you’re on an ERC-free product. Some lenders offer discounted, tracker or offset mortgage deals that come with no early repayment charges.
  • If you’re on your lender’s Standard Variable Rate (SVR). If your fixed or tracker deal has ended, then your mortgage may have reverted to your lender’s SVR. You generally won’t pay any early repayment charges if you repay a mortgage that’s on your lender’s SVR.
  • If you’re paying off a small amount of your mortgage. Most lenders will allow you to make a capital repayment to your mortgage of up to 10% of the balance each year without incurring an early repayment charge. This is true even if you’re on a fixed-rate or tracker-rate product. Check with your lender what amount they will allow you to repay without incurring ERCs.

You may also avoid paying early repayment charges if you’re moving home and you want to ‘port’ your mortgage (see below).

What if I am moving home?

When you move home, you pay off the mortgage on the property you sell and take out a brand-new mortgage on the new property (even if it’s with the same lender).

Most lenders will allow you to ‘port’ your mortgage product onto the new property. When you do this, you keep the same fixed or tracker rate deal and you won’t pay the early repayment charges unless:

  • You’re borrowing less on the new property. Here, you’ll pay ERCs on the difference between your previous mortgage and the new mortgage.
  • You complete on the sale before you complete on the purchase. In this case you’ll generally have to pay ERCs although your lender may refund these to you if you complete on the new purchase within 3 or 6 months.

Find out everything you need to know about porting a mortgage.

 

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