Mortgage Guides

What are early repayment charges?

Updated: Tuesday 29 November, 2011

By Martin Fagan

Early repayment charges on mortgages can cost you thousands of pounds. This guide explains when and why they are charged and how to avoid paying them.

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An early repayment charge (ERC) is a fee you may have to pay to your mortgage lender if you decide to switch mortgages or pay off your mortgage early.

ERCs can add up to thousands of pounds, so it’s important you understand them and check whether a lender charges them before signing up.

In this guide we look at when and why they are charged, how much they could cost and how to avoid paying them.

• When are early repayment charges applied?
• How much will I be charged?
• Why are early repayment charges applied?
• Will I be charged for making overpayments?
• How can I avoid paying an early repayment charge?

When are early repayment charges applied?

Early repayment charges can be applied when you:

1. Pay off your mortgage in full, or
2. Pay off your mortgage in part, or
3. If you switch mortgages.

They are designed to lock you in to a mortgage deal and discourage you from switching.

You may think a lender would be grateful to you for paying off your debts early. Alas, no. Mortgages (and personal loans) levy ERCs because the profitability of your mortgage to the lender is calculated on the basis that you’ll pay every payment. To pay the loan off early means the lender will make less profit and so they claw back potential lost profit with an ERC.

Not all mortgages come with ERCs and most that do will only apply them for a set period of time. Early repayment charges normally come with special mortgage deals like fixed-rate mortgage deals and discounted deals, but they may also be applied to tracker mortgages.

Typically, the period when ERCs are levied will be the same length as the mortgage’s fixed-rate or discounted rate deal period. However, there are exceptions and you should watch out for mortgages that lock you in with an extended ERC period.

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How much will I be charged?

The amount you will be charged depends on the size of your outstanding mortgage and its terms and conditions.

The ERC will normally be charged as a percentage of your outstanding loan. For example, if you have £200,000 left to pay on your mortgage and your lender charges a 2% ERC, it will cost you £4,000 to leave.

Some lenders charge the same percentage ERC throughout the ERC period, while others have variable percentages that decrease as you approach the end of the ERC period.

Other lenders price their ERCs as a number of months’ interest - usually three or six months.

The cost of any ERC and the period during which it is applied should be laid out clearly in a mortgage’s key facts illustration, in section 10, entitled “What happens if you do not want this mortgage anymore?”

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Why are early repayment charges applied?

ERCs are applied by the lender to discourage you from switching and to ensure that you are profitable for them. Lenders need to lure you in with attractive deals, but they also need you to stay put so they can continue to profit from your custom.

The costs of setting up and funding your mortgage may be greater than the arrangement fee and initial interest rate you pay, so lenders need to ensure you stay with them for a significant period of time, so they can make their money.

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Will I be charged for making overpayments?

Whether you will be charged early repayment charges for making overpayments on your mortgage depends on your lender and mortgage product.

Some mortgages allow you to make unlimited, penalty-free overpayments, while many allow you to overpay up to 10% of your outstanding loan each year. However, any overpayments over this limit or, on some mortgages any overpayments at all, will incur ERCs.

Normally the ERC will be charged as a percentage of the amount you overpay - for example if you overpay by £1,000 and your ERC is 2%, you will be charged £20.

If your mortgage lender does apply early repayment charges to overpayments, it may be advisable to save up all the overpayments you could make until the ERC period ends, and then make one lump sum overpayment.

However, you’ll need to do the sums, as this depends on the time left until your ERC period ends, the interest rate you are paying on your mortgage and the interest rate you could get on your savings.

For more information on this, read the Creditchoices.co.uk guide to overpaying your mortgage.

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How can I avoid paying an early repayment charge?

The best way to avoid paying an early repayment charge is to choose a mortgage that does not apply ERCs. However, the Catch-22 is that most competitively priced mortgages on the market almost always come with ERCs.

So, you have to think carefully when choosing your mortgage. If you’re sure you won’t want to switch mortgages, move house or repay your mortgage before an ERC period ends, then it shouldn’t put you off.

But if you need more flexibility, you are likely to be better off with a mortgage without tie-ins. The rates may be slightly higher but, if you do need to move, switch or repay your mortgage, you’ll avoid being hit with a hefty ERC.

If you already have a mortgage, are within the ERC period and you want to move house, you may be able to avoid charges by “porting” your mortgage to the new property i.e. taking the mortgage with you and keeping the same rate and terms and conditions. However, not all lenders will let you do this and, if they do, they will need to approve of the new property.

If you already have a mortgage, are within the ERC period and you want to switch mortgages, there is not a lot you can do to avoid paying the ERC. You may decide to wait until the end of the ERC period to switch mortgages. However, if your current mortgage rate is much higher than that of the new mortgage you want to switch to, it may be worth paying the early repayment charges to escape.

To work out whether it’s worth it, you need to take into account the old and new interest rates, the length of the ERC period, the cost of the ERC and any set-up fees for the new mortgage.

Before making this decision, it may be worth seeking advice from an independent financial adviser.

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THINK CAREFULLY BEFORE SECURING ANY DEBTS AGAINST YOUR HOME.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON A MORTGAGE OR ANY OTHER DEBT SECURED ON IT.