In February this year I moved on to a two-year fixed rate mortgage of 5.54 per cent with Nationwide. I currently have £41,000 left to pay.
My father has very kindly offered me £20,000 to pay off part of the mortgage to get my costs down.
I know I will have to pay some charges for doing that, as I can only overpay 10 per cent of the balance each year before the early repayment charge kicks in.
Would I be better to pay off the £20,000, pay the fee and continue with the existing mortgage? Or would it make more sense to remortgage early, look for a new lender, and perhaps get a better interest rate for the rest of the term?
Possibly there is a better option I haven’t thought about but any guidance would be greatly appreciated.
Mortgage help: Our weekly Navigate the Mortgage Maze column sees broker David Hollingworth answering your questions
David Hollingworth replies: Many borrowers like the idea of a fixed rate so they know exactly where they stand for their month-to-month budgeting. The potential downside is that the lender will generally expect you to lock into the deal.
Lenders will price their rates depending on the market rates and cost of funds at the time.
To protect their interests, they therefore put an early repayment charge in place. That acts as a penalty for those that pay off early, covering the potential cost to the lender.
Overpaying your mortgage
Lenders recognise that borrowers want some flexibility to overpay and cut the balance of the mortgage more quickly when possible.
As a result, most fixed rates will allow a certain level of overpayments each year without incurring any penalty.
Most lenders typically offer up to 10 per cent per annum without charging an ERC and some lenders can be more generous than that.
Most lenders base the 10 per cent on the outstanding balance at the time you repay, but your lender Nationwide will base the 10 per cent on the initial balance at the start of the fixed-rate period – allowing you to pay back a little more than 10 per cent of £41,000.
Your yearly allowance should also reset again in February, which could give you the chance to take off another 10 per cent of the original balance in just a couple of months’ time.
You may want to clarify the exact timings that apply with Nationwide.
How do early repayment charges work?
There are a few elements you need to balance before deciding how to proceed. The first thing is to check exactly what the ERC on your specific deal is.
Depending on when you took the deal, this could affect the level of charge that you face.
Nationwide reduced some of the ERCs that applied on its mortgages toward the end of 2023, which may have coincided with you securing the deal ahead of your existing deal ending.
Nationwide also typically reduces the percentage that it charges as each year of the fixed rate passes.
That means that the level of penalty could fall come February, possibly saving the equivalent of 0.5-1 per cent on the penalty – depending on the terms of the deal.
Waiting a couple of months could therefore help reduce the penalty to a minimum, if you decide that you want to go ahead and pay off the entire lump sum.
Early bird penalty: Most fixed mortgage deals come with an early repayment charge
Should you pay an early repayment charge?
When deciding whether to incur an ERC, the usual approach is to look at whether the reduction in your monthly payments will make up for the cost of the penalty over the remaining lock-in period.
If you switch the remainder of the mortgage to a better rate, that could help to mitigate the cost incurred on the penalty over the rest of the fixed period.
However, your mortgage is relatively small, so you will need to be careful when looking at a new deal and do those sums carefully.
Fees should be avoided as they will potentially take a big chunk out of any savings you can make from getting a better rate.
Look across the market, but remortgaging to a new lender will typically require you to have a minimum mortgage amount of £25,000 anyway.
It’s worth noting that Nationwide will allow borrowers to switch to a new deal in the final three months of their current deal without an ERC, which could allow you an earlier break from the current higher rate.
Savings interest
As well as factoring in how much you may save on mortgage interest, you should also consider what you might be able to earn on any cash savings – if you only overpaid by the ERC-free overpayment allowance and kept the rest of the money tucked away instead.
One-year fixed rate bonds can pay 4.8 per cent at the moment. That is lower than the mortgage rate but would not incur the penalty.
You should also factor in if you may need to pay tax on any savings interest, should that take you over the personal savings allowance.
Although the ERC will be hundreds not thousands, I still think it could be a close call to pay it, once you have taken advantage of the two annual overpayment allowances, current savings rates – and factored in that you may be able to switch to a lower rate a little early, too.
NAVIGATE THE MORTGAGE MAZE
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