14:13 15 April 2013
Mortgage rates have been in freefall for quite some time now and, while this is ideal if you're in the process of buying your first home or remortgaging, it can be extremely frustrating if you took out a long-term mortgage a few years ago and are now locked into a much higher rate.
For example, if you had taken out a five-year fixed rate mortgage three years ago, one of the best buys was from the Co-operative Bank with a rate of 4.49%. It required a 25% deposit.
Yet if you applied for a five-year fix today (albeit with a larger deposit of 40%) you would pay just 2.59% with Yorkshire Building Society, reverting to 4.99% after five years. It comes with an arrangement fee of £1,345. (Overall cost for comparison 4.1% APR.)
Or, if you chose a two-year fix, you would pay 1.74% with Chelsea Building Society, reverting to 5.79% after two years. This deal has a £1,545 fee. (Overall cost for comparison 5.2% APR.)
Because these offers are so tempting, you might be wondering whether it's worth getting out of your current mortgage early and switching to one of them. To do this, however, you will usually have to pay a fee - known as the early repayment charge (ERC) - and often this is costly. In fact, it can work out to be thousands of pounds.
ERCs can apply whether you took out a fixed rate mortgage or a variable tracker - and they apply to all of the mortgages above. But does it ever work out more cost-effective to pay the ERC to switch to a cheaper mortgage?Here we find out.
How much do early repayment fees cost?
This depends. Early repayment charges vary from lender to lender and from mortgage to mortgage. In some cases the charge will be fixed for the duration of the mortgage deal. In other cases, it will be tiered which means it will decrease with every year of the deal.
The basis on which lenders will charge ERCs also varies. Some will charge it on the outstanding loan amount, while others will charge it on the original loan amount. So it's important to check your ERC carefully before deciding whether or not it's worth paying.
Examples of fixed ERCs
Nationwide charges a consistent 5% of the outstanding loan amount on a five-year fixed rate mortgage, 4% on a three-year fix and 3% on a two-year fix. It also charges 3% for a three-year tracker and 2.5% for a two-year tracker.
Barclays charges 3% of the outstanding loan whether you have a two, three or five-year fix. It also charges 1% for the majority of tracker deals - although one of these deals comes with fee of 3%.
Examples of tiered ERCs
On fixed rate mortgages, First Direct charges 3% of the original loan amount in the first year and 2% thereafter for the term of the deal.
Yorkshire Building Society and Chelsea Building Society both also have tiered ERCs on their five-year fixed rate and five-year tracker mortgages. You'll pay 5% of the original loan amount in the first three years, 4% in year four and 3% in year five. If you opt for a two or three-year deal you'll pay 3%.
With five-year fixed rate mortgages, the Co-op charges 5% of the outstanding loan amount in the first year, 4% in the second year, 3% in the third year, 2% in the fourth year and 1% in the fifth year.
Will it pay to switch?
Given that ERCs can run into the thousands, it's hard to imagine the savings made by switching to a cheaper mortgage could actually make forking out this large sum of money worthwhile.
So we've done some number-crunching with mortgage broker London & Country to investigate.
Let's say that, three years ago, you took out the Co-op mortgage fixed at 4.49% until August 31, 2015. You now have a mortgage of £200,000 with 20 years left to run so you are paying £1,264.22 a month on a repayment basis.
You decide to switch to Chelsea Building Society's two-year fixed rate mortgage with a rate of 1.74%. This means you'll now pay £987.32 a month on a repayment basis, saving you £276.90 a month.
This means that, over the remaining two years of your current deal, you would save £6,645.60.
But, to get out of your Co-op mortgage, you have to pay a fee of 3% on your £200,000 mortgage debt - which works out to be £6,000. You also have to pay an arrangement fee to Chelsea of £1,545 to take the deal - and fork out valuation fees and legal costs on top.
It would appear on the face of it that you would NOT be better off switching to Chelsea deal as you'd effectively end up forking out £7,545 to save £6,645. But it's not actually that simple.
After two years at the 1.74% rate, your outstanding mortgage balance would be £182,982.16.
In comparison, if you were to stick with the Co-op's 4.49% deal, you would have a bigger £187,071.07 left to pay on your mortgage after two years.
The reason for the difference is that the lower interest rate allows your repayments to eat further into the capital of the loan, thus reducing the debt faster.
This means that you would save £4,088.91 with the Chelsea deal. Add this sum to the £6,645.60 you saved earlier and you get a grand savings total of £10,734.51.
Deduct the £6,000 ERCs and Chelsea's £1,675 arrangement fee, and you still get a saving of £3,059.51.
As you can see, the sums can get mind-boggling, so if you need some help, call our mortgage partner London & Country on 0844 209 8725 for fee-free independent advice.
When it nearly always pays to switch
When a mortgage deal comes to an end, you will be automatically moved onto your lender's standard variable rate (SVR). According to our figures, the average SVR sits at 4.4% and some are even higher (Chelsea Building Society charges a whopping 5.79%), so it's a good idea to switch to a better deal as soon as possible. Not only will you save money when you get to the new mortgage but there will be no ERCs to pay to escape your SVR deal either.
Similarly, if you're on a lifetime tracker that's no longer competitive, you can often switch without paying an ERC - although do check the terms and conditions of your mortgage to be sure. Again, this could save you thousands of pounds a year so don't hesitate in switching.
Visit our mortgage channel to compare what deals are available.
YOUR HOME MAY BE REPOSSESSED IF YOU DON'T KEEP UP REPAYMENTS ON YOUR MORTGAGE.
Follow Rachel on Twitter @RachelWait
Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.
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