Understanding Mortgage Exit Fees

With the excitement of homeownership comes the shock of unexpected costs. Mortgage exit fees can sometimes be one of these. As such, it is important to understand what they are, their potential impact and possible mitigation strategies.

Types of Mortgage Exit Fee

There are basically two types of mortgage exit fee:

1. Early Repayment Charges (ERCs): These charges are usually applied if you choose to repay your mortgage during a fixed mortgage interest rate period. At any given point during their mortgage term, usually 25-30 years’ long, borrowers tend to be on either a fixed or a tracker mortgage interest rate, typically applicable for a period of 2 or 5 years. When their current 2- or 5-year fixed or tracker rate period ends, borrowers choose a new rate from a menu offered by their lender. This process of choosing a rate, usually a 2- or 5-year fixed or tracker rate, is repeated throughout the life of the mortgage. If a borrower chooses a tracker rate, which consists of the Bank of England base rate plus a margin, there is usually no early repayment charge associated with repaying the mortgage before the end of the tracker rate period. On the other hand, if the borrower chooses a fixed rate, there is usually an early repayment charge associated with repaying the mortgage before the end of the fixed rate period.  

2. Discharge Fees: When you pay off your mortgage, the lender must remove their legal charge over the property, a process that involves some paperwork. Discharge fees cover the administrative costs incurred by the lender when your mortgage is paid off.

Scenarios Where Exit Fees Might Apply

There are several scenarios in which you are likely to face exit fees:

1. Re-mortgaging: If you decide to re-mortgage with a different lender, perhaps to increase your loan amount and release some home equity, or extend the mortgage term or achieve a lower short term mortgage rate, you are likely to face exit fees from your current lender.

2. Selling Your Property: When you sell your house and  pay off your mortgage, again, you are likely to face exit fees from your lender.

3. Excess Overpayments: Some mortgage agreements allow for a certain amount of principal overpayment each year, usually up to 10% of the outstanding mortgage balance. You might face early repayment charges if you exceed this limit.

The Cost of Exit Fees

Early Repayment Charges: Early repayment charges can be quite steep, especially during the earlier years of a fixed interest rate period. For example, if you are on a 5-year fixed mortgage interest rate and repay the mortgage loan during the first year of the 5-year period, the early repayment charge might be 4.5% of the mortgage loan amount. If you repay the loan during the second year, it might be 4.25% of the loan, and 4% in the third year, 2.5% in the fourth year and 1% in the fifth year. If you are on a 2-year fixed mortgage rate and repay the loan during the first year of the 2-year period, the early repayment charge might be 1.5% of the loan amount. If you repay the loan during the second year, it might be 0.75% of the loan.

Discharge Fees: These fees typically range from £0 to £300, depending on the lender and the specifics of your mortgage agreement. In any event, they are almost insignificant compared to early repayment charges.

Strategies for Minimizing or Avoiding Exit Fees

While mortgage exit fees can be a significant expense, there are strategies you can potentially employ to reduce or even avoid them:

1. Choose Your New Short Term Mortgage Interest Rate Strategically: When it comes to choosing your new short term mortgage rate as the expiry of your current short term rate approaches, consider if there is a reasonable possibility that you might want to sell your property in the near future. Suppose that the new short term fixed rates are significantly more attractive than tracker rates, but also that there is a reasonable chance that you might sell your property within the next 2 – 4 years. In this situation, it may be worth considering a 2-year fixed rate rather than a 5-year fixed rate, even if the latter is slightly lower than the former.  

If you end up selling your property within two years, your early repayment charge is likely to be considerably lower than what it could had you been on a 5-year fixed rate. On the other hand, if you do not sell your property within two years, you will still have had the option of a lower early repayment charge. You can also choose a new 2-year fixed rate again if you think you might still sell in the short term.  

2. Time Your Moves Strategically: If you are on a fixed short term rate and are thinking of selling or remortgaging your property, try and time the completion to coincide with the end of your fixed rate period. If the completion date slips by a few weeks, consider choosing a tracker rate for the new short term rate period in order to avoid early prepayment charges associated with a fixed rate.

3. Choose Mortgage Products with Favorable Exit Terms: All other things being equal, such as loan-to-value ratio, the mortgage interest rate and length of the mortgage term, consider choosing a product with a lower exit fee, especially early repayment charges.

By staying informed about the potential impact of mortgage exit fees, especially early repayment charges, and employing appropriate approaches strategically, you can make decisions that could minimize the financial burden of such charges. Additionally, consulting with a financial advisor or mortgage broker can provide further valuable help and guidance.

FAQs:

Q. What is the difference between an early repayment charge and a discharge fee? 

A: An early repayment charge (ERC) is a fee you may incur for paying off your mortgage early, particularly if this is within a fixed, as opposed to a tracker, interest rate period. An ERC can be quite substantial, as it is typically calculated based on a percentage of the loan amount. A discharge fee or deeds release fee covers the administrative cost of closing your mortgage account when you repay your mortgage. This is usually a small fee.

Q. How much are mortgage exit fees?

A: The early repayment charge if you are on a 5-year fixed mortgage interest rate and repay the mortgage loan during the first year of the 5-year period might be 4.5% of the mortgage loan amount. If you repay the loan during the second year, it might be 4.25% of the loan, and 4% in the third year, 2.5% in the fourth year and 1% in the fifth year. If you are on a 2-year fixed mortgage rate and repay the loan during the first year of the 2-year period, the early repayment charge might be 1.5% of the loan amount. If you repay the loan during the second year, it might be 0.75% of the loan. Discharge fees vary, but generally ranges between £50 and £300.

Q. Can I avoid paying an early repayment charge?

A: If you are on a fixed short term rate and considering selling or remortgaging your property, try and time the completion to coincide with the end of the fixed rate period to avoid paying an early repayment charge. If the completion date slips by a few weeks, consider choosing a tracker rate for the new short term rate period in order to avoid early prepayment charges associated with a fixed rate.