Mortgage Redemption Penalties

Note: A new mortgage deal might seem tempting when you consider the savings that can be made. But then you realise that mortgage redemption penalties will cost you more than you stand to gain. This article examines the danger of these innocent looking penalties.

Whenever you start a new mortgage, or switch an existing deal, look out for mortgage redemption penalties. They apply to most ‘special’ deals (such as discount rates, low fixed rates etc) and are a crude mechanism designed by lenders to keep hold of their business.

When a borrower has the audacity to move their debt elsewhere the poor impoverished lender is deprived of huge amounts of interest that they would have otherwise received over the life of the mortgage. Here they are, having spent all that money on marketing and subsidising the cost of your ‘special’ low-rate mortgage deal and within a matter of months you find someone offering a better rate and you want to leave them.

But they have to recoup the money that they spent on ‘capturing’ your custom, and then make some profit. So they don’t intend letting you go. Well, not until they have made an adequate profit from your business or received ‘compensation’ in the form of a redemption fee.

Once you sign up for a mortgage with a new lender there is likely to be a clause in the agreement that requires you to pay a certain fee if you move your mortgage elsewhere within a certain time. This may be one year, two years or even as long as five years. In many cases these penalties last longer than the special deal itself!

Typical penalty rates are six months interest or a fixed percentage, such as 5%, of the amount of the capital that is repaid early. It doesn’t take long to work out that such ‘fees’ could run into thousands and completely wipe out any savings you might make by switching your mortgage.

For example, if you arranged a $100000 mortgage on a 2 year fixed discount rate of 4% then six months later spotted an even more attractive 2 year discount rate of 3% you might be tempted to change lenders and save yourself $1000 per year in interest charges. But then you realise that if you transfer within the 2 year period an early redemption penalty would be due (6 months interest on the loan = $2000).

All of a sudden switching deals doesn’t seem as attractive. You’d have to find $2000 just to move lenders and would then take the whole of the new 2 year fixed rate to recoup that penalty.

So from now on, pick and choose your mortgage deals wisely. Before you accept a deal that carries a redemption penalty, make sure that you won't need to move your mortgage elsewhere until after the penalty period has passed.

And if your chosen mortgage deal lasts for a certain time (eg 2 year discount rate) make sure that the redemption penalty period doesn't last any longer (eg 3 years). Otherwise, the special rate will disappear and you'll be left paying a much higher standard rate during the third year. Of course, you could consider switching to a new deal, but the redemption penalty would mean that you would have to hand back most of the money saved during the first two years. These overhang periods are dangerous and will cost you unnecessary money. Avoid them at all costs.

Other remortgaging costs

Beside any potential early redemption penalties there are a range of other costs associated with remortgaging. These costs can rapidly mount up destroying any savings that are made through the new mortgage deal. These costs include; discharge fees for the old mortgage, survey and valuation fees on the property before the new lender will agree to the loan, legal fees and any high ratio lending fees.

It’s wise to calculate the potential savings that will be made during the period of the new mortgage deal and then deduct all of these costs from it before you decide whether to switch lenders. Be aware that some lenders may cover some of these remortgaging costs, such as the legal and valuation fees in order to secure new business.

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