What Is An Early Repayment Charge?
Most people reading this blog will have heard of an early repayment charge or an ERC. Chances are that you have been confronted with the prospect of having to pay an ERC or have seen it written in the small print on your mortgage contract. However, there is also a good chance that a lot of you reading this blog have never heard of an early repayment charge. Some of you might not have a clue what it actually means, and some of you will quite rightly not understand why you are being charged for coming out of your mortgage contract. SO if you are asking yourself what is early repayment charge liability, then this blog might be for you.
So what is an early repayment charge? And is it worth knowing how to avoid early repayment charges on loans? An ERC is literally exactly what it says. It is a charge that can be applicable to a mortgage or any other kind of loan, if you break the agreed contract terms by leaving the agreement or paying back the loan too early. Depending on how soon you pay back the loan, the size of the loan, and the specific terms of your agreement, the more you could be liable for. It may seem a bit strange to be charged for paying back a loan too early as ideally you would want to be debt free as soon as possible, but it actually makes a lot of sense.
How Do Early Repayment Charges Work?
So, an early repayment charge is a charge that you may have to pay to come out of a credit agreement that you have made. This can be a mortgage, a personal loan, or some other agreement where a loan has been provided. Normally when you get finance like a mortgage, you agree to borrowing terms. These can be, the amount you are looking to borrow e.g. £250,000. The length of time that you intend to take the loan out for e.g. 25 years. The rate of interest that you will be charged by the bank e.g. 3%. And in the case of mortgages specifically, the fixed rate period e.g. 5-years fixed.
If you break the agreement then a lender could potentially insist that you pay them a fee because they will essentially be losing out on making a profit. Normally with mortgages, this comes down to the fixed rate period being broken. A lender will often insist that you stay with them and on your mortgage interest payment plan for a minimum of 2 to 5-years so that you can a) have financial stability with your loan for a period of time and b) so that they can ensure that they make some profit by charging you 24 to 60 months of interest on the loan. If you sell your property or switch your mortgage lender or product before this fixed period is up, your current lender may charge you.
How To Calculate Early Repayment Charge
What is an early repayment charge on a mortgage? And how much are early repayment charges on mortgages? Well this depends on a few different factors and not all lenders will actually charge an ERC. Normally if you are going to be charged an ERC, it will be based on a percentage of the outstanding mortgage balance. When you apply for a loan, your mortgage advisor will generate something called a mortgage illustration or a KFI for you, which will detail the specific rules of your loan. In this, it will specify exactly how much you might be charged every year of your initial fixed period, if you break the contract. This is again repeated in your actual mortgage offer document.
For example, if you want to know how to work out early repayment charges on mortgage loans, you can of course ask your mortgage advisor. But, you can also simply look at your original offer document where it will say something along the lines of:
Should you wish to repay this loan early, you will be liable to an early repayment charge. On or before __/__/__ (date) you will pay 3% of the balance of the loan. On or before __/__/__ (date) you will pay 2% of the balance of the loan. On or before __/__/__ (date) you will pay 1% of the balance of the loan.
How Much Are Mortgage Early Repayment Charges – Example
If you have a £300,000 mortgage on a 5-year fixed period, you will normally have to agree to keep the loan for at least 5-years or risk paying an ERC on the loan. Your mortgage offer specifies that you must keep your loan until the 11th of April 2028. Right up until the 11th of April 2024 you will be liable to a 5% ERC which could be a maximum of £15,000. Up until the 11th of April 2025 you could be liable to an ERC of 4% or up to £12,000 depending on the balance of the loan at the time.
On or before the 11th of April 2026 you could be liable to an ERC of 3% up to £9,000 depending on the balance of the loan at the time. Then until the 11th of April 2027 you could be liable to 2% ERC up to £6,000 depending on the balance of the loan at the time. And finally up until the 11th of April 2028 you could be liable to 1% ERC up to £3,000 depending on the balance of the loan at the time. If you decide to clear the loan by selling and moving or remortgaging the property after the 5-year fixed period has ended, you will not be liable to any early repayment charges.
Higher ERCs (Early Repayment Charges)
If you take a 5-year fixed product mortgage for example, you are liable to a higher ERC the earlier you redeem the loan. The closer to the end date of the fixed product, the lower the ERC. Normally this goes down in percentage. Some lenders can charge quite a high ERC. For example, the Santander mortgage early repayment charge can be up to 7%, depending on the product. To find out how much is an early repayment on a mortgage, simply find out the balance of your loan, see if you are still within the initial agreed fixed period, and then check with your mortgage advisor or on your original mortgage offer to see what percentage your early repayment might be charged at.
How To Avoid Early Repayment Charges On Mortgages
How to get out of mortgage early repayment charges. An unavoidable certainty or something that you can actually do? Unfortunately in most cases, you can’t actually avoid the early repayment charge if you have agreed to the terms of the product. If you agree to have you mortgage loan fixed for 5-years and you end up selling the property or switching the mortgage before this period is up, then you will more than likely need to pay the ERC.
However, if you do something like a mortgage port, this may be a way of avoiding the early repayment charge. A mortgage port is where you transfer your current mortgage to a new property, without actually breaking the mortgage contract and ending the mortgage early. You can potentially move the entire mortgage to a new property and remain on the same mortgage deal and rate, avoiding the charge. But, not all products will allow you to port, so it is important to make sure that you are clear with your broker and the lender that you would like a product with this option.
If you are unable to avoid paying an early repayment charge, you may actually be better off paying the charge and moving to a new product. What do we mean by this? Let’s look at it this way. How is early repayment charge calculated? It is a percentage of the outstanding balance of the loan remaining. e.g. 1% of £200,000 (£2,000). If you are switching to another mortgage lender with a lower interest rate, the money that you are saving in interest over time compared to the early repayment charge you will need to pay may make it worth it.
Can The Lender’s Standard Variable Rate Help Avoid Early Repayment Charges?
Some borrowers and even some advisors might recommend that you move onto and stay on the lenders standard variable rate to avoid early repayment charge restrictions. This is because when you come off of your fixed period product, you will automatically go onto the lenders variable rate which is not fixed and can go up or down. Because you are not fixed into a specific rate, most lenders will not charge you an ERC to come off the variable rate.
To some, this might seem appealing as it does give you flexibility to switch and change your loan when you like, however it can be very expensive. Variable rate are essentially a rate that the lender decides on and can charge whatever they like because it is not part of their competitive fixed rate offerings. So, you could go from a fixed 2-year product at 3.99% on to the standard variable rate at 6% for example. Yes, you have the freedom to move or change your mortgage deal when you like, but you could end up paying much more per month for your mortgage.
Example Of SVR Vs. ERC
An example of this could be:
- £250,000 loan fixed at 3.99% for 2-years paying £1,318 per month.
- The fixed 2-year period ends and you move onto the lenders SVR which is 6% currently but could change.
- That means that your payments per month will go up to £1,611 every month that you remain on the variable rate.
- Coming off your fixed rate a year early would mean that you are liable to 1% ERC which would be £2,500.
- On the SVR you will not necessarily be charged any ERCs to come off of it, but if you stay on the SVR for 8 months, you will have last just as much money as you would have paid with the ERC.
Speak To A Qualified Mortgage Advisor
If you are looking at getting a mortgage or have a mortgage already and want to know how much are mortgage early repayment charges, the best thing to do is to seek the help and guidance of a qualified mortgage professional. A mortgage advisor will be able to go through your needs with you in regard to the duration of your mortgage loan and your future property plans. If a flexible mortgage with little or no ERCs is important to you, your advisor can factor this in and help you to find the most competitive deal for your circumstances.
Getting in contact with an advisor at Oportfolio mortgages has never been easier. Give us a call today or send us a message to have a chat with one of our advisors today. We are here to help.