Early Repayment Charge on a mortgage in the UK

The early repayment charge (ERC) is a term that anyone considering overpaying their mortgage or a remortgage needs to be familiar with. It can significantly affect the cost-effectiveness of such a decision. Many mortgages contain a clause for an additional charge for early repayment of part or all of the obligation before a certain period. Failure to be aware of the existence of an ERC can result in the borrower incurring high costs instead of saving on interest, which can negate the financial benefits of overpaying or refinancing. In addition, with a remortgage, the need to pay an ERC can make it less cost-effective, and in some cases even unprofitable, to change the mortgage to better terms.

What is an early repayment charge?

An early repayment charge (ERC) is a charge a lender may apply if you repay your mortgage, overpay more than your allowance, or switch or remortgage before the end of the period set out in your mortgage offer (usually the initial deal period). For a regulated mortgage, the lender must show the maximum early repayment charge, if one applies, in your illustration (ESIS) and in your mortgage offer, so check these documents before you commit.

An ERC is usually a percentage of the amount you repay early; if you repay in full, that is the outstanding balance. On some deals the percentage reduces over time. As an illustration only, on some five-year fixed-rate deals the ERC is 5% in year one, falling by 1% each year. An ERC can apply if, during the ERC period, you overpay more than your allowance or remortgage to another lender.

Why do lenders charge early repayment charges?

Lenders arrange funding for fixed and discounted deals in advance, so repaying early can leave them with costs. For a regulated mortgage, the FCA requires any ERC to be a reasonable pre-estimate of those costs.

How much is the early repayment fee?

ERCs are typically between 1% and 5% of the outstanding balance if you repay in full early, or of the extra amount if you overpay above your allowance. The exact charge depends on your lender and deal, so check your mortgage offer. How the percentage changes over the initial deal period (fixed, tracker or discount) also varies from deal to deal.

The rules are slightly different for partial overpayment of a mortgage. Many lenders let you overpay a set amount each year without an ERC, for example up to 10% a year. The limit, whether it is based on the original loan or the current balance, and how the year is counted vary by lender. If you overpay more than your allowance during the ERC period, an ERC may be charged on the amount above the allowance.

Does early repayment of a mortgage affect creditworthiness?

Repaying a mortgage early can affect your affordability for future borrowing and your credit score in different ways.

Affordability for future borrowing:

• Once the mortgage is repaid, you no longer have a monthly mortgage commitment. This lowers your debt-to-income ratio and can improve your affordability when you apply for new borrowing.

Credit score:

• Paying off your mortgage early may cause a temporary dip in your credit score, because lenders often see older mortgage accounts as a sign of stability, but your score should recover over time if you manage your credit well.

• The closed account and its repayment history normally stay on your credit file for six years.

• Some lenders like to see that you can manage different types of credit, so closing an account such as a mortgage might dent your score for a while.

Is it possible to avoid the Early Repayment Charge?

There are several ways to avoid or reduce an ERC. One is to repay or switch after the ERC period has ended. ERCs normally apply only during the period set out in your mortgage offer. Some lenders do not charge an ERC once you are on their standard variable rate (SVR), but check your own terms.

It is also a good idea to spread overpayments over several years. If your deal has an overpayment allowance (for example up to 10% a year), staying within it each year means no ERC is charged on those overpayments. Check how your lender calculates the allowance.

Some lenders offer remortgage incentives such as cashback or paying your standard legal fees, which can help offset the cost of switching. Check any conditions, as cashback may have to be repaid if you repay the mortgage early. It is also possible that the terms of a new mortgage will be good enough for the savings to cover the ERC charged by your current lender. You will not avoid the ERC in that case, but switching could still be worthwhile – see the comparison below.

Some mortgages have no ERC, for example certain tracker deals and lenders’ standard variable rates. Their rates can change, so your payments may rise.

There are further options if you are buying your next property:

• If you are moving home, ask your current lender whether you can port your deal or borrow more from it. Some lenders do not charge an ERC when you switch to a new deal with them near the end of your current one.

• If you want to transfer your mortgage to another property, consider mortgage porting. Some lenders will allow you to do this without requiring you to pay the ERC.

When is it worth paying the Early Repayment Charge and when is it better to stay on your current deal?

To see whether it is worth remortgaging before the end of your initial deal period (fixed, tracker or discount), compare both options over the same period – for example, the months left on your current deal. You will need:

• the ERC, taken from your lender’s redemption statement;

• the interest rate and monthly payment on your current deal;

• the interest rate and monthly payment on the new deal;

• the fees for the new deal, such as arrangement, valuation and legal fees;

• the number of months left on your current deal.

Then compare:

1. Cost of staying: the interest you would pay on your current deal over the remaining months.
2. Cost of switching now: the ERC, plus the new-deal fees, plus the interest you would pay on the new deal over the same months.

Also check what rate applies after each deal ends – for example, the rate your current deal moves to when it ends, and how long the new deal lasts.

If the cost of switching now, including the ERC and fees, is lower than the cost of staying, paying the ERC may be worthwhile. If it is higher, it is usually better to stay on your current deal and switch once the ERC period has ended. For exact figures, ask your lender for a redemption statement and speak to a mortgage adviser.

Summary

Because of how complicated the calculations can be, you should consult your mortgage broker regarding the Early Repayment Charge. This is a very important detail in the context of possible mortgage overpayments as well as the possibility of doing a refinancing.

It is worth being aware that, as with commission, the ERC is a cost that needs to be factored into the calculation of the profitability of the mortgage. Sometimes a deal with a lower interest rate but a higher ERC is the better choice; in other cases it is worth accepting a higher rate for more flexibility, with a lower ERC or none at all.