Redemption Penalty workaround

gil13

I have been doing some number crunching and wondered if some of you could check the angles. We are on very low fix with ERC of 3 years (some quite hefty fees which I knew about and accepted, reason - started a family etc..) and was thinking about how we could keep our monthly payment down over the next three years rather than a sharp increase. We already have some savings and ISA's stashed, dont want to touch the ISA's if possible.

Considering various options at the moment including paying the penalty and moving to a long term fix, possible an offset type; paying off some of the mortage (allowed 10% pen free) which would lower the monthly payments; or going on to interest free for the 3 years we are tied and then at the end make a large payoff to cover the difference between the capital repayment and i/o style, plus probably a bit more on top. I checked with the BS and this is possible for a small fee to go to I/O, so might be well be an option.

We have the money now to do any of these options but as we have toddler and possibly wanted to add another, wife stopping work etc looking to keep the montly payment down whilst avoiding paying out a redemption pen. So the above seems a workaround for a few years whilst we settle things down.

The problems I see is that the I/O would still be at the SVR which can go up and down and also the term would go down 3 years whilst leaving the same amount of capital to repay which would result in a higher monthly repayment -but then we would be making a capital repayment at this point, so might not make much difference when recalculated. So I accept there is some uncertainty to this with regards to interest rates, but then in saying that the ERC's do come down years 3,4,5 So I guess I would just have to keep crunching the numbers.

Anyone done anything similar or have any comments to the above?
Would welcome your input!

UK007BullDog

I am a bit confused about your post. But the best for you is to change your repayment mortgage to an interest only mortgage. It will not change the deal you are on. It will still be fixed at the rate you took out. So you would be paying the same interest only payment for the next 3 years (if that is how long your fix still has to run).

I would never pay an ERC if there is a way around it (Well there is not really) Why give the bank money for nothing?

The fix you are on now will be less in interest rate than any fixes available now.

If I misunderstood then please post again to explain to us.

homer_j_3

Are you with the portman by any chance?

MarkyMarkD

The OP has an extended tie fixed rate product, I think.

There's no way around the ERC on such a product.

The only way to reduce the payments is to overpay the maximum you can without triggering an ERC - i.e. 10% per annum, according to the OP's post. And if you don't have the 10%, then you can't do that either.

It's almost definitely not worth paying the ERC and switching to another lender/product. ERCs aren't set to be economically worth paying!

gil13

Thanks for your reply, to clarify we are currently on a cheap fix which ends soon and then we are tied to the BS SVR for 3 years with ERC during that period. So to keep the monthly payment down from a sharp rise was thinking of going I/O for the remaining 3 years and then at the end of that to make a capital repayment from savings (which we already have and will earn 3 years interest on).

UK007BullDog

It will only make sense with the savings if the interest rate is higher than the SVR of the lender. And yes as you will be on their SVR it can go up and down.

As you are on the lenders tracker it does not have to move up and down with the BoE rates. They can up or lower it as they like.

Are you sure you are on a SVR and not on some sort of BoE rate tracker?

MarkyMarkD

It makes sense to me that the extended tie is at SVR.

I am a bit confused with the OP's strategy. There's no point going interest only to reduce repayments, if you have spare money sitting in savings. As UK007 says, it would only be worthwhile if your savings rate was higher than SVR - which is unlikely.

The interest cost at SVR will be minimised by reducing the term to the lowest you can meet the repayments on or, better, by making the maximum 10% overpayments at the start of each year and also reducing the term to the lowest you can meet the repayments on.

gil13

Thanks for yr replies, I think I need to flesh it out a bit. This all came about because I felt like I wanted some certainty about monthly payments and had been considering the FD offset, 10 years (which was 5.15% cracking offer, now 5.49% still good). I knew I had the ERC's and have been taking advantage of a low fix rate 2.25% for the last 18 months and we have budgeted for the increases (on 135k/21 yr remaning approx) about £400 pm increase, obviously subject to SVR and changes in interest rates in the future. Then I thought, could I workaround the ERC's (7% going down I think to 3% during the 3 years.) whilst keeping the monthly budget down. I worked out that if I payed off 10% it would reduce my payment by approx £110 but if I went I/O it would reduce by £142 approx. Obviously this idea is subject to what the interest rates might do so the figures will change and is not such a big difference to when I first started number crunching. But then also we have the cash that we could have made the 10% capital repayment with earning a bit of interest, so this is added to equation. Going back to the FD 10 year fix, over the course of 10 years I worked out that even if I did make the ERC payment that against the BS typical SVR I would still be better off. (difference between the FD 10 year and the SVR was apprx 148 pm x 10 x 12 = 17,760 - ERC 9450 (yeah i know!) = 8310, saving 692 per year. Not that I would stay on an SVR for 10 years, but interesting all the same. So I guess I was just wanting to check whether I am being really thicked and have missed something and whether this stacks up in the particular case. To go I/O during an ERC period and then at the end make a capital repayment to get you back where you were (plus a bit extra on top..) IYSWIM.

MarkyMarkD

I don't know what to add to what I've already said.

The way to minimise your interest cost, during your ERC period, is to repay as much capital as possible. That can be done by using the 10% overpayment facility to its full extent, and by reducing the term which will increase the required capital payments.

Going "interest only" achieves the opposite of what you really want to achieve.

Reducing payments isn't what matters - you've got money available in savings. Reducing interest charged is what matters, and that's proportionate to your capital balance outstanding.

jamesd

At 821 a month on interest only and with 135k remaining that's an interest rate of 7.3%. You should discuss your situation with a mortgage broker two or three months before the current deal ends. It's possible for you to benefit from paying the 7% ERC if you can get a mortgage deal 2.34% or more lower than the SVR of the current lender. That would save you 2.34% of the mortgage each year leaving you roughly even after three years. But that difference is pretty marginal, you'd really want a bigger difference.

Go for an interest only mortgage, preferably one that allows overpayments. That way you can pay only interest if money is tight. Your biggest risk here is finding that you can't pay the mortgage on the reduced income you're considering and it's probably not prudent to lock up all of your savings in the mortgage. If you do find that you are stuck with the current deal, at 7.3% each 10,000 paid off the mortgage amount owed will reduce your monthly payment by 61. That same 10,000 could pay the monthly interest only mortgage payments of 821 for a year (12.2 months).

So, first step is see if you can get a mortgage deal that is enough better to make switching pay. If you get a deal in the 5-5.25% range than saving and investing will be a better idea than overpaying on the mortgage. If you're stuck on the SVR, there are investments that can pay 9% or more so you might consider using a 50:50 mixture of savings and investments to pay off 20k of the mortgage and keep the remainder as your cushion for emergencies and to cover the mortgage for a while if you become unemployed or ill.

Calculating interest saved by paying off capital is fine but that money is also risk protection and you should not use it all to save interest. Being caught short in a cash (credit ) crunch is far worse than paying some extra interest.

The great news is that you seem to have exploited the lower initial interest rate to accumulate savings and investments. Nicely done, exactly what you should have done in that situation.

Now isn't a good time to be losing one of the household incomes. Better to wait a year or two if you can handle that. Then you'll have savings to cover the final year of the mortgage deal and the prospect of a cheaper ongoing rate as well as higher income from inflation-based salary increases to help out. Three percent salary increases for three years gets you an extra 9.2% income and that's probably enough to make paying the mortgage considerably more comfortable.

This comment has been limited by not knowing the actual mortgage interest rates (now and SVR now), not knowing the actual ERCs and possibly not knowing the capital amount currently owed on the mortgage.

gil13

Thanks jamesd for your thoughts. I put some of the figures into mortgage advisor (free edition) got the following (approx figs):

Repayment 135k (current SVR 7.3 / 21 yr remaining) 1050 pm.

Interest Only (different mortgage calculator) 821 pm = difference of 229 pm
>> over the 3 yrs of ERC's = £8244.

I then looked at the mortgage schedule which showed accumulated capital paid off over the 3 years on the standard repayment (135/21/7.30%) which gave a figure of £9101, leaving outstanding balance of £125,898 after 3 years.

So if we went I/O for 3 years (paying approx £229 pm less than a repayment style) at the end of the 3 years I would need to find £9101 to basically get back to where we would have been if we had gone repayment and not I/O for those 3 years. So at the end of the 3 years I have just serviced the interest for 3 years and the capital remained at 135k. I then pay off £9101 (but will pay more than this probably 15k), brings amount owning to 125k (or 120k or whatever, if I pay more). BUT... then 3 years have elapsed so only have 19 years left to pay off if I wanted to keep original term (125k/19/7.3%) would mean a monthly payment of £1016 - but at that point would remortgage to a longer term fix, maybe 1.5-2% lower (assumptions I know !) so a payment might be about £892 ish', but this might be lower if, as is likely, we pay off a bit more. In doing this I have kept the monthly payment down, avoided any ERC's & maintained cash & ISAs at a uncertain time. Of course we could just pay off 10% this year and then 10% in Jan 09, which would leave about 110k outstanding (at SVR 7.3%/21 years; well just under by that point) would work out about £855 pm, but like you say it's nice to have a bit of a cash cushion in uncertain times.

So am I missing something and being really thick or does this is a wierd roundabout way make sense. My main purpose was to keep the monthly payment down rather than a big jump (about £400) from the current very low fix over the next three years. From my figures it seems better to go I/O for the 3 years rather than make a capital repayment to the mortgage. Perhaps because in the early years of mortgage most of a standard repayment pays the interest and not the capital.