Record low mortgage rates: is it worth paying a penalty to get out of a fix early?
A mortgage price war has been raging recently, making fixed rate homeloans more competitive than ever. Just last month, challenger Atom Bank stunned the market with its five-year fix (up to 60% loan-to-value or LTV) at 1.29% and this was closely followed by HSBC’s counter attack offering its lowest ever five-year mortgage rate at 1.69% (to 60% LTV).
With such headline-grabbing rates, borrowers already on a fixed-rate mortgage which looked competitive when they took it out, may now feel they are paying over the odds for their loan. But given the Early Repayment Charge (ERC) which accompanies most fixed rate mortgages, and which can amount to thousands of pounds, can it ever be worth cutting your losses for a cheaper fix?
While most borrowers these days won’t revisit their mortgage until their deal comes to an end, given the record low rates, mortgage brokers say clients are increasingly asking whether switching to a new deal early can benefit them in the long run.
Ray Boulger, senior technical manager at John Charcol mortgage adviser, says: “Clearly when rates have fallen, people are much more likely to ask the question of whether they should switch early to a new, cheaper deal, particularly if rates have fallen a lot.
“In the last six months, rates have been falling, extending the difference between what people are paying now and what they can get on a new deal. This difference is more prominent now than a couple of years ago.”
However, the mortgage brokers also note that while switching deal can work for some, for others they would actually be worse off, so it’s important to look at a number of factors to determine whether such a move is right for you. Here are seven points you should consider:
How long is left on your current deal and what are the penalty fees?
The ERC is designed to cover the cost of a lender’s funding so that borrowers don’t all desert the deal if rates come down. The charge can be substantial as it’s often calculated as a percentage of the total amount still owed on the loan (the ‘balance’).
A useful tip according to David Hollingworth, associate director communications at L&C Mortgages, is to look out for a reduction in the ERC over time.
“Many lenders will reduce their early repayment charges each year. So typically, with a five-year fixed rate you would pay 5% of the balance to get out of the arrangement in year one, 4% in year two, 3% in year three, then 2%, then 1% in the final year. So as well as looking at the current ERC it makes sense to check whether that may be about to step down a notch in coming months, helping you save 1% on the mortgage amount.
“The longer the lock in period that remains on a currently high interest rate, the more likely it is that you will be able to switch to a better deal that will save any ERC back over that period. A borrower with two years left on a high rate is more likely to save enough to cover the ERC and have additional benefit than someone who only has a few months on the current deal,” Hollingworth says.
Boulger adds that as a rough and ready calculation, if you’re three years into a five-year fix and the ERC is a flat 5% throughout the fixed term, particularly when the ERC is higher than your mortgage rate, it won’t be worthwhile, but if it reduces by 1% each year the closer you get to the end of the fix, it might be worth paying.
Should you remortgage or get a product transfer?
There are two options for borrowers to consider and those are to remortgage completely to a new deal and/or lender or simply choose a product transfer to a lower rate with your existing lender.
A remortgage is a switch to a completely new deal, and usually lender, involving a valuation of your property and legal and arrangement fees, though these are sometimes paid by the new lender. A product transfer simply involves switching to a new deal in your lender’s range. Hollingworth warns that you will still incur the ERC, even with a product transfer. “Some lenders may offer the ability to switch to a new deal before the end of the current one without a charge but that would typically be in the months leading up to the deal end, not a year or two before,” he says.
What’s more Boulger points out that not all lenders allow product transfers, even if you pay the ERC, so this option may not be available.
The size of your mortgage
The amount of money you still owe on your mortgage is an important factor to consider as the cost of an early redemption may be more or less proportionate to the long-term savings you’re hoping for.
Boulger explains: “If you have a £50,000 mortgage and you have a 2% fee to pay, so £1,000, this is disproportionate to the savings you’ll make. If you have a £500,000 mortgage and a £1,000 fee, there’s a smaller impact.”
Another point to bear in mind is that it may be possible to roll in fees including the ERC to the mortgage and Hollingworth says this means you are increasing the mortgage size and will therefore pay interest on the increased borrowing over the life of the mortgage which is “another cost to account for”.
How long should you fix for?
If you’ve another two years left on your fix, it shouldn’t be too difficult to calculate whether you can save money on another two-year fix. However, if you’re already considering moving to a new deal, switching to a slightly longer-term deal could help you lock in the record low rates available now.
Data from Moneyfacts reveals mortgage rates have been coming down across the board, including on longer fixes. On a 10-year fixed rate (maximum 85% LTV), average rates have dropped to 3.67% in May 2017, down from the 4.27% recorded in May 2015. Five-year fixes (based on an 85% LTV) have gone from 3.8% in May 2015 to 2.97% now.
Rachel Springall, finance expert at the site, says: “In such a low interest rate environment it’s important to consider fixing for the longer-term to lock into a decent rate as there is no telling when interest rates may rise during economic uncertainty.”
Consider your personal circumstances
If your personal circumstances have changed since you originally took out a mortgage -perhaps you’ve gone self-employed or two incomes have been reduced to one – this could have a big impact on obtaining a better mortgage deal.
Andrew Montlake, director of brand, marketing and communications at mortgage broker firm Coreco, says: “Your circumstances may have changed since the initial mortgage was taken out and in recent times lenders have changed many of their underwriting rules, specifically around affordability, which may make it more difficult to obtain the loan you require this time round.”
If you know there will be a change in your personal circumstances in the near future making it more difficult to get a mortgage, locking in a cheaper rate now for longer may also prove to be beneficial.
Wider range of options available
Don’t just consider the typical products – you could consider an offset mortgage for instance.
A mortgage broker may help you find the right deal and the right lender, however Hollingworth says it’s important to ensure your adviser will look across the whole market, not just a limited range of lenders.
“You should also check whether they will charge a broker fee. All brokers will receive a fee from the lender for introducing business to them but some brokers charge customers a fee as well. Others, will not charge a broker fee in addition to the lender fee.”
Property value and equity
When you remortgage, the deal you’ll get will depend on the LTV, and as a rule of thumb, the higher the LTV the higher the interest rate you will pay. When it comes to buying a first property, borrowers will know the purchase price but with a remortgage, people will need to have a good idea of their property value which can be more difficult, according to Boulger.
“You need to get as good a feel for the valuation as possible so you’re in the right ball park for the LTV and subsequent mortgage deal as it’s not the same borrowing at 60% as borrowing at 80% LTV,” he says.
According to mortgage trade body the Council of Mortgage Lenders (CML), the typical remortgage LTV is 60%, helping borrowers tap into average mortgage rates of 1.83% for a two-year fix, 1.96% for a three-year fix, 2.39% for a five-year deal and 2.76% for a 10-year fix, figures from Moneyfacts reveal.
‘Make sure there will be genuine cost savings’
It’s very important to do the maths before you go ahead with a switch to make sure you will make genuine cost savings, as the calculation can be very finely balanced when factoring in all the fees, Hollingworth says.
He gives this example:
In April 2015, Halifax offered a five-year fix at 5.14% for first-time buyers on a 90% LTV with a £999 fee which would carry an ERC of 4% until 30/6/17 when it would drop to 3%. That would mean an ERC of £6,000 dropping to £4,500 after the end of June.
If the borrower owes £150,000 now and has 25 years remaining then they would currently be paying £889 per month. If the property value has grown and the balance has been reduced through monthly payments so that the LTV is now 75% then for the remaining three years, HSBC offers a 1.89% rate fixed for three-years to 75% LTV with no fee and covering switching costs too.
Switching the £150,000 to 1.89% would cut the monthly payment to just under £627 per month, a saving of £261 per month or £3,137 per year. Hollingworth calculates that would save over £9,400 over the three-years so even after paying the £4,500 ERC, this is a near £5,000 saving.