Mortgages, True Costs Revealed - Early Redemption Charges

An Early Redemption Charge is a fee you must pay for paying off a before the agreed end of a deal with a lender.

Why are such penalties applied?

In order to attract borrowers, lenders are often forced to compete by offering mouth-wateringly cheap deals in the first two or three years, sometimes for longer periods.

The hope is that borrowers will then stick with them not just through the course of the deal itself but for several years afterwards.

Clearly, if borrowers were to jump from one mortgage to a cheaper one whenever they wanted to, lenders could lose a lot of money. So they protect themselves by applying charges on those who do.

Either way, lot of borrowers don't become aware of these charges right up until when they wish to or pay off their mortgage early.

However, with most early redemption fees being in the thousands, it is vital you know beforehand if you will be liable to pay up and how much the cost might be.

Redemption fees can be calculated in the following ways:

• Percentage of the original mortgage loan value


• Percentage of the balance still owing on the mortgage


• Percentage of the amount repaid


• Number of months' interest

For short-term fixed or discounted mortgages of, say, two years, the interest penalty will generally be a set amount of months' interest.

In the case of longer-term mortgage deals, the fee may be set on a sliding rate. For example, say you have taken out a five-year fixed mortgage.

The redemption fee might be:

• Six months' interest for the first year of the mortgage


• Five months' interest for the second year


• Four months' interest for the third year


• Three months' interest for the fourth year


• Two months' interest for the fifth year.

There are two main types of redemption fee. The most common is one that applies throughout the lifetime of the deal itself. So, a two-year fixed rate mortgage may have penalties that apply during the deal period, but not after it has ended and you are back on the lender's variable rate.

The five year-deal, above, is one example of this.

In some cases, especially where a very cheap deal is on offer, the lender may apply an "overhang", committing you to staying with the mortgage even after the deal is over. So, you might have to stay on that lender's variable rate for several years after the deal ends.

In most cases, unless the deal on offer is exceptionally good, it makes sense NOT to opt for a home loan with a long overhang.

The simple way to avoid any such costs is to look for a mortgage that doesn't impose early redemption fees.

But it may be hard to resist a good deal, especially when variable rates are high. In that case, it is better to opt for a shorter fixed rate deal.

Although you may pay a higher APR in the short term, it may be better to do as you then have the flexibility to shop around for a cheaper mortgage at a time of your choosing.