ERC - unlawful penalty?

hewhohuntselves

Hi.  I understand that English law generally prohibits penalties which are unrelated to actual (or expected) loss.  On that basis, how is a fixed ERC not an unlawful penalty?  Especially in the case of remortgaging with the same lender at a higher fixed rate.

Thanks!

biscan25

When a mortgage provider sells a fixed mortgage, they will hedge the risk of interest rates rising using swaps of equivalent term (in aggregate). Also, the mortgage provider will lose out on interest due for the remainder of the fixed term. It probably costs more than £1000 to arrange a mortgage too.
I presume the fixed ERC would bear in mind the magnitude of these expected losses, otherwise, as you say the clause would be unfair.

DullGreyGuy

hewhohuntselves said:

Hi.  I understand that English law generally prohibits penalties which are unrelated to actual (or expected) loss.  On that basis, how is a fixed ERC not an unlawful penalty?  Especially in the case of remortgaging with the same lender at a higher fixed rate.

Do you mean English Law or the Law of England and Wales?

Punitive damages aren't generally allowed under the law in E&W which therefore means penalties must be broadly aligned to costs (which can include loss of profits) however this can be done on an average basis and in recent years the courts have been more convinced by the arguments that there is benefits to both sides of having a fixed cost agreed up front for breach of contract than the uncertainty of unspecified damages.

However you are not talking about damages for breach of contract but instead an exit fee and the laws around these sorts of things are much weaker. 

You aren't the first one to complain though so there are plenty of cases not upheld on the ombudsman website like https://www.financial-ombudsman.org.uk/decision/DRN2660666.pdf 

Edi81

You signed up for it. Nothing unfair in an ERC. 

hewhohuntselves

Edi81 said:

You signed up for it. Nothing unfair in an ERC. 

Just because someone signs up to something does not (a) mean it is lawful or (b) that it is fair... Hence the reams of consumer protection legislation / guidance existing in the UK!

And thanks to everyone else for the replies!

kingstreet

Here is the gist of a rejected complaint to the FOS re ERCs;-

"In very simple terms, when a lender offers a fixed rate, both the lender and borrower are tied in to the fixed rate for the whole fixed term. The lender has to raise the funds it lends out on the money markets. It has to pay for those funds – generally over the period it borrows them. It relies on income from borrowers repaying the mortgages to cover the costs of the funds it has lent. It budgets for that income based on the length and level of fixed rates. So when borrowers repay early, the lender won’t receive the income it was anticipating, and needs to service its own borrowing.

It can insure against that in various ways, but there’s a cost either to having the borrowing end early – or to protect against those costs. As a result, fixed rate mortgages include a clause in the mortgage agreement which allows the borrower to exit the mortgage early – but only in return for paying an ERC. The purpose of the ERC is to compensate the lender for the early end of the fixed rate period. Repaying a mortgage early isn’t a breach of the contract, it’s something specifically allowed for, as long as the borrower pays the charge for doing so. The rules of mortgage regulation include provisions about ERCs. In summary, they say that an ERC must be able to be expressed as a cash value, and must be a reasonable pre-estimate of the costs resulting from early termination of the mortgage. Subject to that, there’s no restriction on how a lender calculates its ERC and, crucially, a lender is allowed to estimate the risk and costs of early termination across a group of mortgages; it doesn’t have to do so on an individual basis. So a lender can calculate its ERCs based on a reasonable pre-estimate of the costs of early termination of a group of mortgages – not on the actual cost, or estimated cost, of a borrower ending their individual mortgage early."

Details of a number of such complaints can be seen here;-

https://www.financial-ombudsman.org.uk/decisions-case-studies/ombudsman-decisions

kingstreet

"The purpose of the ERC is to compensate the lender for the early end of the fixed rate period. I don’t agree that it’s a penalty – which has a strict meaning in law (a charge levied for breaching a contract). Repaying a mortgage early isn’t a breach of the contract, it’s something specifically allowed for, as long as the borrower pays the charge for doing so."

Smudger74

kingstreet said:

Here is the gist of a rejected complaint to the FOS re ERCs;-

"In very simple terms, when a lender offers a fixed rate, both the lender and borrower are tied in to the fixed rate for the whole fixed term. The lender has to raise the funds it lends out on the money markets. It has to pay for those funds – generally over the period it borrows them. It relies on income from borrowers repaying the mortgages to cover the costs of the funds it has lent. It budgets for that income based on the length and level of fixed rates. So when borrowers repay early, the lender won’t receive the income it was anticipating, and needs to service its own borrowing.

I am in a situation where I have completed my repayments for the mortgage term on the 1st of the month because I prefer my payments go out at the beginning. My officla term ends on the 31st. How is it the mortgage company loses out financially that they have to charge me £1250 early repayment? 

I have accepted it now but it doesn't sit right with me.

dunstonh

Smudger74 said:

kingstreet said:

Here is the gist of a rejected complaint to the FOS re ERCs;-

"In very simple terms, when a lender offers a fixed rate, both the lender and borrower are tied in to the fixed rate for the whole fixed term. The lender has to raise the funds it lends out on the money markets. It has to pay for those funds – generally over the period it borrows them. It relies on income from borrowers repaying the mortgages to cover the costs of the funds it has lent. It budgets for that income based on the length and level of fixed rates. So when borrowers repay early, the lender won’t receive the income it was anticipating, and needs to service its own borrowing.

I am in a situation where I have completed my repayments for the mortgage term on the 1st of the month because I prefer my payments go out at the beginning. My officla term ends on the 31st. How is it the mortgage company loses out financially that they have to charge me £1250 early repayment? 

I have accepted it now but it doesn't sit right with me.

The contract will be date specific.   You are just the wrong side of that date.  If the date was changed by a month, then someone else will just be the wrong side of that and will also call it unfair.   That is the nature of a line in the sand.  You are either one side or the other.

kingstreet

Smudger74 said:

kingstreet said:

Here is the gist of a rejected complaint to the FOS re ERCs;-

"In very simple terms, when a lender offers a fixed rate, both the lender and borrower are tied in to the fixed rate for the whole fixed term. The lender has to raise the funds it lends out on the money markets. It has to pay for those funds – generally over the period it borrows them. It relies on income from borrowers repaying the mortgages to cover the costs of the funds it has lent. It budgets for that income based on the length and level of fixed rates. So when borrowers repay early, the lender won’t receive the income it was anticipating, and needs to service its own borrowing.

I am in a situation where I have completed my repayments for the mortgage term on the 1st of the month because I prefer my payments go out at the beginning. My officla term ends on the 31st. How is it the mortgage company loses out financially that they have to charge me £1250 early repayment? 

I have accepted it now but it doesn't sit right with me.

The lender will be compensating a market counterparty who supplied the original rate-swap which made your product possible in the first place. They work to fixed parameters and there are no grey areas which can be exploited.