Early Repayment Charges: Could You Owe 25%?
If you are considering taking out an equity release loan, then you have probably spent time comparing interest rates. However, one feature that often catches homeowners by surprise is the early repayment charges (ERC).
Unfortunately, in some circumstances, these charges can be significant, with certain older equity release plans charging you up to 25% of the initial amount borrowed.
Whilst that figure can sound alarming for some, it is important to understand that it does not automatically mean you will pay 25%, or even that you will pay any early repayment charges at all.
Thankfully, most modern equity release loans are now more flexible than they were years ago, with many allowing early voluntary repayments and downsizing options.
Nevertheless, if there’s any chance you may want to repay your lifetime mortgage before it comes to an end, then it is well worth understanding exactly how these charges work before you sign up for the equity release loan.
In this guide, we will explain exactly what equity release early repayment charges are, whether you will exactly owe 25% and why lenders apply these charges.
We will also discuss the different ways that ERCs are calculated, and the different situations where you might be able to avoid paying them all together.
What Is an Early Repayment Charge?
An early repayment charge is a type of fee that might apply to you if you repay your equity release plan sooner than what was originally agreed.
Unlike traditional mortgages, a lifetime mortgage will continue until the last owner, or borrower either passes away or moves into a care home [1].
It is important to understand that equity release loans are designed to last for many years, often even decades. Because of this, lenders make long-term financial commitments when it comes to providing the money to homeowners.
If the loan is repaid much earlier than what was anticipated, then the provider will likely suffer a financial loss.
The early repayment charge is designed to compensate the lender for that potential loss, should it occur. However, this doesn’t mean that every borrower will pay an early repayment charge [1].
In fact, the majority of people keep their equity release plan in place until it comes to a natural end, when the homeowner passes away or moves into a care home, meaning that the majority of people won’t ever have to worry about paying back an early repayment charge.
Could You Really Owe Back 25%?
The short answer is yes; it is possible to owe up to 25% of the loan amount if you choose to pay back the loan early, but only in a few certain circumstances.
Some equity release plans include gilt early repayment charges, where the lender includes a maximum charge that can be capped at 25% of the original loan amount.
However, that doesn’t mean everyone repaying an early repayment charge automatically pays 25%.
Instead, many loans and products do not charge you anything. Others only charge you a small amount, whereas others only cap the amount at 25% in specific market conditions.
Why Do Equity Release Providers Charge for Early Repayment in The First Place?
Early repayment charges might seem unfair at first, especially if you’re simply paying back money you’ve borrowed from your own property.
However, it is important to understand that equity release providers don’t operate in quite the same way traditional mortgage lenders do.
When they lend money through lifetime mortgages and other equity release loans, these loans often last for years, or even decades.
In order to be able to finance these long-term loans, equity release lenders have to invest in long-term assets, including government bonds.
The early repayment charge helps to cover the potential financial shortfall that the lender would experience if this happens.
Without these protections in place, equity release lenders would likely need to charge higher interest rates across all equity release products, which would make it a lot harder for other people to take out an equity release loan.
The Different Types of Early Repayment Charges
It is important to understand that not every equity release lender calculates early repayment charges in the same way.
Understanding which structure applies to your equity release loan is one of the most important questions to ask your equity release adviser before you take out an equity release loan.
Below is a list of the different early repayment charges that your lender could charge you [2].
1. Fixed Early Repayment Charges
Many more modern lifetime mortgages use a straightforward early repayment charge, known as a fixed early repayment charge. This gives the borrower more certainty, as they know from the day their plan starts exactly what the maximum charge would be if they chose to repay their equity release loan early [2].
2. Tapered Charges
Some providers use a type of tapering over a set number of years. This means that the repayment charge gradually falls each year, until it eventually disappears altogether.
These products can be very attractive for homeowners who think that they might downsize later in life, during their retirement for whatever reason [2].
3. Gilt-Linked Early Repayment Charges
Many equity release providers use gilt-linked charges, which are more complicated than other types of equity release early repayment charges. This is because they are based on the movements in Government bonds and yields [2].
Put simply, if gilt yields fall after you take out your equity release plan, then your lender might face a financial loss if you repay the equity release loan early. However, if the gilt yields rise, then the lender might not suffer that loss, meaning that no charges will apply.
When Might You Want to Repay Equity Release Early?
Whilst equity release loans are intended to be a long-term solution for homeowners over 55, it is important to understand that people’s circumstances can change.
There are many different reasons why someone might need or want to repay their equity release loan early, some of which are listed below for you.
1. Selling Your Home
Even though equity release loans are designed to last until the homeowner passes away or moves into a care home, some people need or want to sell their home in order to downsize or move closer to their family.
Whilst some people choose to repay the equity release loan early, others are able to move their lifetime mortgage to the new property.
2. Coming into Money
Some homeowners unexpectedly inherit or come into money later in life. This might mean that rather than keeping their outstanding equity release loan, they might decide to repay their lifetime mortgage early to clear any debt or outstanding payments.
3. Switching To a Better Product
It is important to understand that interest rates change over the years. This means that some homeowners choose to take out another lifetime mortgage if significantly lower rates become available. For some people, this might save them money in the long term.
Can You Make Partial Repayments Instead?
Yes, one of the biggest improvements in equity release is the increased flexibility in partial early repayments. In fact, many modern lifetime mortgage equity release loans now allow people to make partial, voluntary repayments without triggering any form of early repayment charge.
Depending on the lender you opt for, you might be able to repay up to a certain percentage of the original loan without receiving a penalty.
Making regular voluntary repayments can reduce the amount of compound interest you are charged, protect your inheritance and reduce the overall cost of your loan.
However, it is important to understand that not every equity release loan offers people the chance to make a partial early repayment, which is why it is incredibly important to seek professional equity release advice before taking out your equity release loan.
How Can You Find Out If Your Equity Release Plan Has Early Repayment Charges?
Before taking out an equity release plan, your equity release adviser will explain exactly how your plan works and whether or not you will be expected to make any early repayment charges should you wish to repay a part of the loan.
When you take out an equity release loan, your equity release adviser should provide you with documentation that shows whether any early repayment charges will apply, how they are calculated, how long they will last and what the maximum amount you can be charged is.
This is called the illustration, and your adviser will provide you with this before you take out the equity release loan.
Are Early Repayment Charges Becoming Less Common?
Yes, early repayment charges are becoming less common, as the equity release market has changed considerably over the past couple of years.
This is down to the fact that competition between equity release lenders has encouraged greater flexibility in plans, benefiting homeowners up and down the country who are considering taking out an equity release loan.
Due to this, many equity release lenders now offer fixed rather than variable early repayment charges, voluntary repayment opportunities, inheritance protection, downsize protection and shorter early repayment charging periods.
Questions To Ask Before Taking Out Equity Release
Before taking out an equity release loan, it is important to ask your equity release adviser a number of questions to ensure that you are taking out the right loan for you and your specific needs and circumstances.
Below are just a few questions that you should ask your adviser if you are considering taking out an equity release loan:
- Does this equity release plan include early repayment charges?
- Is there a maximum early repayment charge?
- How long do the early repayment charges last?
- Can I make any voluntary repayments?
- Does the plan include downsizing protection or inheritance protection?
- Are the early repayment charges fixed or based on gilt?
Conclusion
As discussed, whilst fewer equity release lenders are now including early repayment charges as part of their loan, they do still exist in some products and can be known to charge you up to 25% of your loan amount.
However, it is important to understand that not every equity release plan includes early repayment charges of this size.
In fact, many homeowners who take out an equity release loan never pay them at all, as today’s market offers far more flexible options than ever before as more lenders now understand that people’s circumstances can change over the course of the equity release loan.
The most important step is understanding the terms of your chosen equity release plan before signing on the dotted line.
A lifetime mortgage is designed to support your retirement over many years, which is why it is worth considering not only your current needs, but also your feature needs too.
If you are considering taking out an equity release loan but are worried about whether you will be charged any early repayment fees, then it is important to speak to an equity release adviser from the team at Equity Release Warehouse about the best loans for you and your specific circumstances.
