Do Early Repayment Charges Matter?

Metori

Hi All,

My girlfriend and I are first time buyers. We are currently researching mortgages and getting our heads around the whole process. We have started to look at properties and have an idea of what we want to spend.

We have ambitious goals to pay off the mortgage within 5 years, 10 at most. We currently have no kids and have relatively decent jobs. We have between the 2 of us 6 months salary saved as an emergency fund, plus a few grand set by for legal fees, stamp duty, etc. We also have some money allocated for home improvements(which is more than six month of wages for us.) and a deposit. So we feel we are comfortable in over paying a lot on our mortgage.

We are looking to buy a house for around £120,000. We have a £45,000 deposit. So we would be looking at a £75,000 mortgage. We think we could pay this off in 5 years bar no trouble in the future. With that being said we would still like to take out a 25 year fixed mortgage with a 5 year initial rate. We would like to do this as a form of protection in case life gets in the way and we can't pay the mortgage off as quick as we'd like,

The problem I'm having is understanding the Early Repayment Charges. I have run the numbers and from what I can tell it's not a big deal to massively overpay every month on a mortgage and just pay the ERC. Is this a good thing to do?

For example looking at the Halifax mortgage.
Term - 5 years
Initial Rate - 2.94%
Variable Rate - Currently 3.99%
For the Remainder of the Term - 30/11/2020
Overall Cost - 3.7% APR
Product Fee - £0
Deposit - 25-40%
ERC till - 30/11/2020

With Halifax, ERC is calculated once a year by the amount owed on the mortgage. You get a 10% of that amount to over pay without incurring the ERC. You then take the difference of the amount you overpaid and your 10% you are allowed to over pay and then calculate 5% of that to get the ERC charged to you. This can seem like a lot but the amount you save from interest by paying back early seems to outway the negatives.

Here is what I think the ERC would be paid through the total of 5 years at the above fixed rate mortgage. If we overpaid on the above mortgage of £75,000, by £947 a month so a total of £1300 a month including the standard repayment at £343. First year the ERC would be £193, second year £261, third year £331, fourth year £403 and the fifth year would be £477. This would be a total of £1665. I rounded these numbers so not accurate to the pence.

Looking at the overpayment calculator we would save over that period £25,040, minus the ERC charge which is £1,665.58. We would be saving £23,385.

We are not necessarily going to be going with Halifax and some other banks look to have even better ERC rates, such as HSBC, this is just an example. We are trying to factor this charge into our mortgage choice. Can you tell me if this is correct and whether we are missing something that makes this a bad idea?

Thanks for any help.

libf

Personally, I would overpay as much as possible without triggering the ERC, put the rest in a savings account with the highest rate of interest you can get, and then lump sump at the end of the 5 years. That way you make money in interest and still have the funds available should you need them (and you don't seem to snuggle with saving discipline so could actually make it happen).

Metori

Hi libf, thanks for replying. Saving the excess overpayment is a good point and something I'll look into.

Our reason for paying down more now is that with most mortgages interest is calculated daily. This means the quicker you lower your mortgage the less interest you pay. Saving the money over 5 years and paying one big lump sum at the end doesn't save you the same amount of interest as paying off more every month.

Yes putting it into a savings account would earn interest, and I will look to see if I can find a 5 year fixed saving account with an interest rate that could beat a mortgage. Though I think it may be difficult to get something with a good enough interest rate and in the the end would be better off just paying the mortgage down as much as possible.

As for needing the funds, like I mentioned before we already have 6 months salary saved for emergencies and in our budget we have projected for once we move into a new home includes an amount set aside for saving for holidays and gifts, as well as some set aside each month for investments. We have also budgeted a small amount each month to go to a savings account for future repairs and maintenance of the home.

Well we can't predict the future and know for sure we will or won't need the money for something else that we use to overpay. We will be constantly monitoring our needs and assessing whether we should be overpaying as much as we are and adjusting our budget accordingly.

My initial question still stands though, is triggering the ERC a bad thing, especially if we can't get a saving rate better than the saving we would make on the interest charged on a mortgage. Am I missing anything when it comes to calculating the ERC charged? Or how the overpayment would save us money? Would there be any other hidden charges?

libf

On my phone so not in a position to do any sums, but if you say it works out then go for it.

FYI, nationwide have a decreasing ERC on 5 year fixes (5% year one, 4% year two, etc), allow 10% overpayment and have good rates, so might be worth a look.

Also worth considering that trackers don't normally have over payment restrictions, so could potentially work better if rates rise slow and steady as has been predicted.

Liverlad67

Don't forget to use you full isa allowance for the both of you. Your plan is very sensible and doable. You are in a very good situation.

DandelionPatrol

Metori wrote: »

Our reason for paying down more now is that with most mortgages interest is calculated daily. This means the quicker you lower your mortgage the less interest you pay. Saving the money over 5 years and paying one big lump sum at the end doesn't save you the same amount of interest as paying off more every month.

Yes putting it into a savings account would earn interest, and I will look to see if I can find a 5 year fixed saving account with an interest rate that could beat a mortgage. Though I think it may be difficult to get something with a good enough interest rate and in the the end would be better off just paying the mortgage down as much as possible.

Paying down the mortgage is usually a better rate than any savings product.

I suggest you select a baseline savings product and as your propose to overpay, you calculate benefit from not paying the mortgage on that money to the end of your fixed term and deduct the interest from your baseline savings product. If this is more than the ERC, your line of thinking is valid and it is worth paying down the mortgage and accepting the ERC.

You will find that if you put the money in later it will be less worthwhile and ultimately the ERC will wipe out the interest benefit.

You only calculate to the end of the ERC period, because at the point you remortgage, you can pay the mortgage down with the accumulated savings anyway.

dimbo61

Why not look at a 5 year offset fixed rate mortgage.
You can overpay or build up savings in the offset account.
You cannot pay off the mortgage within the fixed period but if you have it fully offset you will not pay any Interest !

TrickyDicky101

If you want to overpay such significant amounts then the sensible approach is to look at mortgages without any ERC (dimbo61 has provided one example of such a mortgage).

getmore4less

Get an offset mortgage or a tracker with no ERC.

If you can pay this off in 5 years interest rate is secondary to your other goals.

Get as much as you can over 25 years.

Offset everything including refurb money(unless savings rate is higher)

draw down as you need it to refurb all income is offset till you spend it.

edit(just read this)

As for needing the funds, like I mentioned before we already have 6 months salary saved for emergencies and in our budget we have projected for once we move into a new home includes an amount set aside for saving for holidays and gifts, as well as some set aside each month for investments. We have also budgeted a small amount each month to go to a savings account for future repairs and maintenance of the home

Offset that lot and you will probably have a tiny net debt paying interest and a massive offset pot to use for cash flow.

Offset look more and more like a no brainer.

getmore4less

Can you tell me if this is correct and whether we are missing something

Looking at the overpayment calculator we would save over that period £25,040, minus the ERC charge which is £1,665.58. We would be saving £23,385.

Thats the wrong comparison over 5 years you can't save £25k

you have to compare over the 5 years saving the overpayment

Eg £75k paid 25year term @2.94 £354pm

2.94% total interest at 5 year point £10,705.41
(then paid off from savings)

You cant save more than that.

overpay to the max will reduce that.

Savings interest on the surplus will reduce that futher.
if you just saved the £947pm @ 2%(net) that would be £2900.

Your interest charges over the 5 years are going to be well under £8k no way you can save £23k

Edit2 : I forgot something.

Eg £75k 25year term @2.94 £354pm

2.94% total interest at 5 year point £10,705.41

savings interest from the overpayments @2% £2900 net cost £7800

overpay to the max(£1300pm) with no ERC total interest £5,946.87

overpaying saves around £1850

less the estimated ERC that leaves around £184 saved.

If you did the fix and pay your ERC thats a total cost of £7612 the equivilent tracker or offset(before any offset funds) could be at a rate of 3.67%

offset £10k rate can be 4.77% £20k, 6.48% £30k,9.31%
(but that does not take into acount lost interest if in savings)

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Aother thing I notice is that £1300pm over 5 years won't clear the mortgage you need £1345pm + a bit for the ERCs

Edit 3:
I suspect a combination of overpayments to the max and saving the rest will wipe out the £184(ish) current estimate of savings.

dimbo61

"Offset look more and more like a no brainer"
As getmore4less has already pointed out an Offset mortgage would suit your needs and there are plenty about with your deposit and LTV.
Put all your savings into the offset pot and save every penny you can into the offset accounts.
Pay for work as and when from the offset savings and reduce the amount of Interest you pay due to savings.
In 5 years you could well be fully offset and then you can move up to a bigger/better property with a large deposit in the offset account to fund the move.