Don’t pay the price for being early

With interest rates on the rise and house prices going through the roof you could be forgiven for spending much of your time focusing on headline rates like APRs and introductory offers. Everyone’s being told to shop around and for many of us that’ll mean finding the answer to one question: what’s the cheapest deal?

Unfortunately cheapest isn’t always best. And that’s never truer than for mortgages and loans. While most people are looking at upfront costs and great introductory deals, it’s worth spending some time looking at the nitty gritty, not only for the product you’re looking to buy, but also for your existing deals.

One of the most important hidden charges to consider is the early redemption penalty. It sounds scary but in plain English it means you’ll get hit with a fee if you decide to pay off a loan or mortgage early, or to move your borrowing to a different product or provider. MoneyExpert.com will take you through the detail…

Repay a loan early? Whatever for?

Being able to repay a loan early should be a major concern when thinking about what product to buy. You never know when extra cash is going to come your way and being able to get out of the loan without costing the earth is a nice option. Flexibility tends to bring peace of mind – and if you can pay off a loan early you’ll benefit from not having to pay interest over the full term of the deal.

You won’t find early redemption penalties on credit cards or overdrafts and you’re most likely to come across them on your mortgage or if you have a personal loan. Each type has their own issues so we’ve split our advice into two sections:

Mortgages

Moving out or paying your mortgage off in full is probably the last thing on your mind when you’re buying a home. But things change and when challenging circumstances prevail there’s nothing like a bit of flexibility to see you through testing times.

If you’re buying a home, ask yourself if your family is likely to grow soon, or if you think you’ll have to move jobs. Will you be able to afford your repayments if you have to go without a salary for a while? Will the house be big enough if the family expands? These possibilities should be planned for, particularly for young people and first time buyers, as the more flexibility you can have the better. Any product with an early redemption penalty will hit you hard if you need a change.

If you can find an appropriate mortgage without an early redemption charge, then great. If you can’t, and you commit to a fixed rate deal, you’re likely to fall foul of the fee at some point – fewer people than ever before remain with the same mortgage provider for life. In fact, 1.8 million homeowners switched mortgage in the past six months.

What will you pay? Well, it varies. But as a standard rule the charge will be on a sliding scale, depending on how long into your fixed deal you are. So, if you’re on a five year fixed rate and you leave in year one, you’ll often pay 5%, in year two 4%, year three 3%, and so on. This may not sound like much but 3% of £150,000 is a hefty £4,500.

Loans

Most loan firms charge around one month’s interest to customers who clear their balances ahead of the term agreed at the start of the loan. So given we’re talking about much smaller sums, the up front fee is considerably less than what you might expect for switching mortgage.

We’d urge you to research the market thoroughly before taking out a personal loan as proportionately the cost of paying your loan off early can be quite high – as much as £250 if you’ve borrowed around £5,000 at a high rate of 10.9%.

Early redemption charges can be misleading – for example if you have to pay two months’ interest to pay off a three year loan early, this is an effective increase in the headline rate of one sixteenth. So a competitive rate of 5.9 would theoretically become 6.26.

But paying off a loan early makes sense as it cuts down your interest bill and helps you become debt-free. It can come at a price and while early redemption penalties can be a price worth paying it is better to avoid them entirely by taking out a loan which doesn’t charge fees. If you believe you will pay the loan off before the end of the term then research the market before you buy.

Redemption penalties are not the only factor to focus on when borrowing but they can be painful if you do pay the loan back quickly. And it is now relatively straightforward to find a company which does not charge redemption penalties.

The Consumer Credit Act of 2004 restricted loan companies to charging a maximum two months interest for early redemption but most companies have cut that to one month. And around one in five of the 90 loans on the market from around 64 companies charge no penalties at all.

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