Could you slash your mortgage costs?

27 March 2009

Some borrowers could be better off redeeming their mortgage early and paying a fee to take advantage of lower rates currently on offer.

Most mortgage lenders will hit you with an early repayment charge (ERC) if you leave the deal within the discount period. This fee is normally a percentage linked to the outstanding mortgage balance. For this reason, most people wait until their discount period ends – this can be after anything from two to 25 years.

However, with new mortgage rates looking surprisingly attractive at the moment, brokers say it might be worth stumping up for the ERC and taking advantage of a better rate. People who took out fixed-rate loans before the Bank of England started to cut the base rate last October, for example, could find they manage to save money even after paying a penalty to leave their existing lender.

Example: Mr Jones has a £120,000 mortgage fixed at 6.49% for five years, which he took out with Nationwide in August 2008. His monthly repayments are £649 (annually £7,788) as he is repaying the loan on an interest-only basis.

Nationwide will charge him a 5% ERC (£6,000) if he redeems the mortgage within the first five years. This means he would have find a new fixed rate that guarantees a lower monthly payment for long enough to make the £6,000 fee worth paying.

According to mortgage broker Money Workout, Mr Jones could consider moving to Alliance and Leicester’s 3.99% five-year fixed loan with no fees. He would need a new mortgage of £126,000 (which would cover his existing loan plus the ERC).

Assuming he was approved for the deal, his monthly mortgage payments would be £418.95 (annually £5,027.40) – a monthly saving of £230.05 and an annual saving of £2,760.60.

Within 26 months, Mr Jones would have offset the cost of the ERC.

Who could benefit?

While some people could benefit from leaving their mortgage early, others could end up paying more so it’s vital you get advice about whether it is worth it for you before you go down this route.

Ray Boulger, senior technical manager at John Charcol, says paying your lender’s ERC in order to get a cheaper rate could be viable for some borrowers, but the sums involved can be difficult.

“If you need to borrow more than 70% or 75% of your property’s value then it probably isn’t worth it as rates for people with low equity stakes aren’t competitive enough,” he adds.

How long your discount period has left to run is another important consideration.

“If you’re in the last year of your fixed rate and the ERC is a flat rate throughout the whole period, then it’s probably not worth moving,” explains Boulger.

One exception is if you are in your final year of your fixed period and your ERC decreases each year. Boulger says: “If your mortgage is relatively low then it could be worth moving even if you are in your final year – just make sure you get professional advice first.” 

The maths

While it is worth speaking to a mortgage broker before you opt to leave your mortgage early, there are some simple mathematical points to consider that should give you an idea of whether it would be worth it financially.

First off, find out what the cost of your ERC will be. Then, unless you have cash to pay this to hand, add this amount to the outstanding debt on your current mortgage. This will, of course, increase the amount of interest you pay back over the term.

Calculate how much your new mortgage repayments will be and work out what the monthly saving is. Calculate how many months it will take before this monthly saving is equal to the ERC you paid.

Looking at the above example, it would take Mr Jones 26 months (two years and two months) before he offsets the cost of the ERC. As his new deal is a five-year fixed, he will continue to benefit for nearly three more years after this cost has been offset. However, had it been a two-year fixed deal, it wouldn’t be worth him moving.

Another important point to bear in mind is that you might have to pay additional fees to close your mortgage account, and could also face fees from your new lender.

Most lenders charge an account closing fee, which can range from £125 to £250. You can find out exactly how much this will be by contacting your lender or by checking your original loan offer.

Matt Andrews, managing director of Money Workout, says: “Look at the fees your new lender will charge you – such as booking/arrangement fees. Most lenders will waive valuation and legal fees, but if not then this cost must be factored in.”

Andrews says people should first of all work out how much they would save in monthly payments over the term of the new deal. The ERC and any additional fees should then be subtracted from this figure. The number you get left with will either be a saving or a loss.

Timing is also key. “Government measures to help banks increase the amount they lend – such as quantitative easing – have not taken their full effect,” says Boulger. “It might be worth waiting for a little bit longer as rates on new mortgages could get cheaper.”

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