Early repayment charges on mortgages

What is an early repayment charge?

It’s a penalty payment imposed by mortgage lenders if you:

• Make more overpayments on your mortgage than its terms and conditions allow
• Pay off your loan early
• Transfer your mortgage to another product before your fixed-rate deal or tie-in period is over - this could typically be two, three or five years, for example

Lenders levy this charge because, when they offer you a mortgage, the terms they apply are made on the understanding that you’ll keep the loan for an agreed amount of time.

If you overpay some, or repay all of the loan early, then you end up paying back less in interest in the long term, so there’s a cost to the lender. The early repayment charge (ERC) is there to compensate the lender for this loss and to discourage borrowers from switching every time they find a better deal.

When does an early repayment charge apply?

You could be billed an ERC if, for example:

• You make an overpayment that takes you over what your mortgage terms and conditions allow
• You pay off your mortgage with a lump sum before your current deal ends
• You move to another lender before your current deal ends
• You switch your mortgage to another product while you’re still in a special-rate period, like a fixed-interest rate
• You ‘port’ your mortgage (take it with you) to a new property, but there’s a gap between the sale of your current home and the purchase of the new one. If the new mortgage starts within a few months, though, you should be refunded your ERC
• The value of your new property is less than your current one and you want to transfer your mortgage

When will an early repayment charge not be applied?

In certain circumstances an ERC may not be charged - for example if:

• The mortgage holder (or their partner/spouse) dies and the loan is repaid using proceeds from a life insurance policy or sale of the home
• The mortgage is paid off from a critical illness insurance payout in the holder’s name
• You have a joint lifetime mortgage and one of you dies or goes into care and the remaining partner pays off the mortgage within a certain timeframe

Am I eligible to pay my mortgage early?

It depends what type of mortgage you have.

If you’re on a variable rate, such as a tracker mortgage, then you may be allowed to make unlimited overpayments without being charged an ERC.

With a fixed-rate mortgage deal, most lenders allow you to overpay with regular or lump-sum overpayments of up to 10% a year of the amount owed without incurring an ERC.

How much do early repayment charges cost?

They’re usually calculated as a percentage of the outstanding amount on your mortgage. The percentage payable is usually between 1% and 5%.

For example, if you want to pay off an entire £100,000 mortgage and the ERC is 5%, the charge will be £5,000.

In some cases, the percentage charged will decrease over the term of your deal. For example, a 5% charge may be applied in year one of a five-year fixed-rate deal, decreasing to 4% in year two, 3% in year three, and so on.

When is it worth paying an early repayment charge?

Paying off your mortgage early - or switching to a mortgage with a lower interest rate - could save you thousands of pounds in interest.

But, in cases where an ERC is payable, you need to calculate whether it will cost you more than you’ll save.

If the cost is too high, then it might be sensible to wait until the end of your deal, when no ERC would apply.

But in some instances, paying an ERC could be worth it.

If you’re switching to a much lower interest rate, then the savings you’ll make could make up for the cost of the ERC. It really is a case of doing the maths.

If you’re unsure, it could be worth talking to a mortgage adviser.

Can I get a mortgage without an early repayment charge?

Yes, there are mortgages that come with no ERCs, like standard variable rate mortgages and certain tracker mortgages. But they’re likely to be more expensive with higher interest fees.

However, if you want the flexibility to switch your mortgage and the option to overpay in the near future, then they can be worth it.

Perhaps you’re self-employed, with variable income. If you expect that income to rise in the following few years, you’d be in an ideal position to pay off more of your outstanding loan.

So, in a case like this, opting for an ERC-free mortgage could be worth it. Overpaying could save you thousands of pounds and help you pay off your mortgage early.

How can I avoid early repayment charges?

If you want to overpay or switch, you can avoid an ERC in a few ways.

• Most deals allow you to overpay by up to 10% of the outstanding balance per year - so use up your allowance if you have the cash to do so. But be careful not to go over the 10% limit
• Go for a deal which has no ERC charges, but factor in the cost of high interest rates and any other fees
• Port your mortgage when you move. Some lenders allow you to take your mortgage with you, meaning you could avoid a penalty ERC
• Simply sit and wait. Check carefully when ERCs will no longer apply to your mortgage. It might be when your initial deal ends and you’re switched to the lender’s standard variable rate, but it could be later. Make sure you don’t get caught out