Homeowners consider the ‘unthinkable’ to save thousands on mortgage deal
In the low interest rate environment, average fixed mortgage rates have plummeted in recent years.
Based on a 90% Loan-to-Value (LTV), back in October 2014, the average mortgage rate on a two-year fix has fallen from 4.23% to 2.81% in October 2016, according to Moneyfacts.
On a three-year fix, average rates have dropped from 4.49% to 3.19%, while five-year fixes now stand at an average of 3.52%, compared with 4.90% two years ago. And 10-year fixes have seen their average rates stoop to 3.12% from the previous 4.98% in October 2014.
For mortgage borrowers who took out the then competitive longer-term fixes (which now seem expensive compared with the current offerings) could you cut your losses and pay a hefty penalty for breaking the terms of a fix towards but save thousands of pounds in interest in doing so?
Alan Cleary, managing director of Precise Mortgages, says that while it’s not a “normal practice”, if an alternative product is cheaper, even when the fees are taken into account, “there is nothing to stop customers doing this”.
Adrian Anderson, director of mortgage broker firm Anderson Harris, says some borrowers are now considering doing just that.
“Fixed-rate mortgages have reduced significantly with some borrowers now considering doing the unthinkable and redeeming their existing rate, paying the penalty and moving onto a new cheaper rate.
“It’s something worth considering but must be done carefully as the borrower will need to look at all of the break costs and set-up costs, rather than simply comparing one rate to another. While it is uncommon for borrowers to do this, more seem to be considering it,” he says.
Does it stack up for you?
Anderson says the early repayment charge (ERC) that the existing lender will charge for redeeming the mortgage is crucial.
Borrowers who are nearing the end of their fixed rate are those who are usually most inclined to consider this, as the longer ago the rate was arranged the more expensive it may be. “If they are near the end of their fixed rate the ERC may not be too onerous,” he says.
He gives another example as to why homeowners may be considering such a drastic move. If the property has increased in value owing to home improvements and the borrower can now apply for a lower loan-to-value, they’ll be able to take advantage of a lower LTV rate and cheaper rates now.
However, it really depends on the penalty charges and exit fees the mortgage borrowers will face.
“Many lenders which offer five-year fixed rates may have a sliding scale reducing the penalty each year from 5% to 4%, 3%, 2% and then 1%. Other lenders such as Santander may have an ERC at 5% over the five-year period which would usually make it very unattractive to pay the large ERC if there is only a short time left on the existing rate,” he adds.
Calculations to show how you could save £1,000s in interest
When thinking about redeeming your mortgage, your lender will work out how much you need to repay in terms of the outstanding loan plus the ERC and any release fee or exit fee.
As an example, if there is an ERC of £10k, then this is added on. Your new lender transfers that amount to your existing/old lender and you carry on making your mortgage payments to your new lender.
Below are some examples where mortgage borrowers may be able to save thousands of pounds in interest and reduce the term of their mortgage by redeeming their mortgage and paying the ERC.
However, if you are thinking of doing this, it’s essential you speak to a lender or broker to discuss your options so you’re aware of exactly what fees to consider and how it will affect your mortgage payments. See YourMoney.com’s guide on How to remortgage for more information.
Anderson Harris gives this working example:
- In the Autumn of 2013, a borrower may have taken a £350k interest-only residential mortgage fixed at 3.59% for five years and the ERC is 5%, 4%, 3%, 2%, 1% (5% in year one and 1% in year five).
- The borrower is just about to enter the fourth year of the five-year rate so the ERC will be 2% of the mortgage loan amount.
- If the existing mortgage is kept in place, the borrower will pay £350k x 3.59% = £12,565pa x2 = £25,130 interest over two years.
- The borrower is exploring paying off the mortgage and paying the £350k x 2% ERC = £7,000 and replace the mortgage with a cheaper long term rate.
- Mortgage considered: a five-year fixed rate at 1.97% with a £995 arrangement fee. The bank will pay for the valuation and legals.
- The interest over two years with the new lender will be £350,000 x 1.97% = £6,895pa x2 = £13,790 interest over two years.
- The existing mortgage of 3.59% would cost £25,130 in interest over two years but the new mortgage will cost £13,790 in interest over two years + £7,000 ERC to redeem the existing mortgage and the new bank fee of £995 = £21,785.
- This is a saving of £3,345 in interest over the next two years (and, most importantly, according to Anderson, is that the borrower is fixed in for the following three years at 1.95%).
Anderson says this saving over the next two years is attractive. However the main driver to consider redeeming the mortgage now and applying for a new five-year fix is for the borrower’s “peace of mind”, knowing what they will pay over the next five years and not worry about what the new rate will be in two years’ time.
“Had this borrower not been concerned about rates after two years they could have considered a circa 1.34% fixed rate for two years with a £995 fee with free valuation and legals and saved even more over the two-year period.”
Financial services company, SPF Private Clients, gives the calculations in redeeming a Halifax rate from mid-2014, 3.39% fixed until 30 September 2019 (60% LTV).
Based on a £200k loan amount, it would cost a borrow £20,340 in interest over the next three years.
But by taking out a new HSBC three-year fix of 1.49%, the borrower would pay £8,940 in interest over the next three years.
Taking into consideration a £6k ERC, £999 arrangement fee, £245 mortgage fee/deeds release fee on exit and a £300 valuation fee, the total cost in remortgaging would stand at £16,484, meaning the borrower would save £ 3,856 by remortgaging now and paying the ERC.