'Cheap' fixed-rate mortgage deals may prove more costly

BORROWERS have been warned to be on the look out for steep early redemption penalties as attitudes shift back in favour of the security offered by fixed-rate mortgages.

Borrowers can pay up to 7,500 in early repayment charges (ERCs) to get out of five-year mortgage deals a year early, according to recent figures from HSBC, nullifying the savings achieved by switching. ERCs are imposed on borrowers wanting out of their fixed-rate mortgage deal before the maturity date and, with lenders taking wildly different approaches to the charges, it's easy to be caught out.

And as borrowers begin to favour fixed-rate mortgages once more, experts have underlined the potential costs of overlooking ERCs when signing on the dotted line. Since interest rates reached the record low of 0.5 per cent in March 2009, borrowers have typically preferred to sit on their lender's standard variable rate (SVR).

But evidence suggests that is changing, with fixed rates coming down in recent weeks and some lenders raising their SVRs. Now persistent inflation has sparked some speculation that interest rates could rise sooner rather than later, a development that would make the current low fixed rates particularly attractive. In particular, the launch of several attractive five-year fixed-rate mortgages in recent weeks has tempted homeowners to tie into cheap long-term deals rather than leave themselves at the mercy of interest rate movements.

Andrew Hagger, head of communications at Moneynet.co.uk, said: "At the moment there will be people getting itchy feet as they see some of the very competitive five-year deals on the market, some now even below 4 per cent, and wishing they could move, but feel trapped by the high get out costs."

Of course, cheaper alternative deals are not the only reason for mortgages to be exited prematurely. Circumstances can force a borrower's hand, such as a breakdown in a relationship mid-way through the mortgage term.

Whatever the reason, it's important to look out for and understand ERCs, which should not be confused with exit administration fees. ERCs are levied on borrowers repaying or switching a fixed or discounted mortgage deal and should be made clear in the mortgage agreement. It is typically a percentage of the loan value or several months' interest so the sums can be substantial.

The fee is normally valid during an ERC period so the lender doesn't lose money and borrowers can only ensure they avoid them by taking a mortgage without ERCs. Some mortgages have "overhang" ERCs, meaning they can be levied even after the term has expired.

The difference in ERCs between the cheapest and most expensive lenders is around 6,090, said HSBC, based on a 150,000 five-year repayment mortgage being redeemed a year ahead of schedule. For example, a borrower with a 150,000 repayment mortgage and wanting out of the 4.49 per cent five-year fix with Nationwide a year early would pay total ERCs of 7,590. In contrast, a borrower on a five-year deal with lenders including Co-operative Bank and HSBC would pay ERCs of less than 1,700 while those on Clydesdale's 4.58 per cent deal would pay 3,000.

Yet it's easy to overlook the potential ERC when signing a mortgage contract, with the interest rate and upfront costs such as administration fees a more immediate concern.

Hagger said: "If you're in the market for a new fixed or discounted mortgage, don't be swayed purely by the headline rate and product fee."

The extent of the ERC depends on the term that has passed. Most mortgages currently on the market have an early redemption penalty of between 3 and 5 per cent in the first year, according to Moneyfacts. This usually tapers off to 2 per cent during the final year of the initial rate period.

In the final year of a five-year fixed deal, lenders including HSBC and Co-operative Bank only charge a 1 per cent of the balance as a get-out fee. In contrast, Northern Rock charges 4 per cent and Santander, Post Office and Nationwide are among those that require 5 per cent.

"To give an idea of the cost differential, someone with a 180,000 mortgage having to stump up a 5 per cent exit penalty would be faced with a bill of 9,000 compared with a far more acceptable 1,800 payable to a lender charging just 1 per cent," said Hagger.

ERCs are applied on virtually all fixed-rate mortgages and a good number of variable rate products. The variable rate deals that are free of ERCs include the 2.35 per cent tracker with ING Direct, the base rate tracker from First direct, and Britannia's 2.49 per cent deal. HSBC has a lifetime tracker at 3.39 per cent without redemption penalties, while those with deposits or equity of no more than 10 per cent can look at the 5.29 per cent mortgage from Lloyds TSB Scotland.