Early repayment fees explained

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What is an early repayment fee?

When taking out a loan, you might think the best thing to do is pay it off as early as possible regardless of the pre-approved time frame, otherwise known as the loan term. The problem with this is that the majority of lenders will place a hefty charges on you for clearing the debt earlier than agreed. When you compare different loans, early repayment fees may be referred to as something else. It's important to look out for terms such as ‘redemption charge' and ‘financial penalty' when taking out a loan so that it doesn't come as a surprise when you try and pay it back early.

Why are there early repayment fees?

Lenders can finance loans in different ways, the majority borrow from wholesale money markets for fixed rates. One reason there are early repayment charges is that the lender could incur charges, so they pass these fees on to you.

A much more common reason is that because you are paying it back early, you are breaking the initial deal and they are losing the interest that they would have otherwise received.

How much does it cost?

The cost will differ from loan to loan, however, there are key regulations set out by the Consumer Credit Regulations 2004 that you should be aware of. A good rule of thumb is that the earlier you pay off your loan, the larger the charge is going to be. The two regulations you should know are:

• If you pay it back with less than 12 months left, they can charge up to 28 days interest
• Over a year, they can add an extra 30 days or calendar month

If you are trying to pay off a mortgage early it can be very costly if you do not exhaust all your options, you should always make sure you do your research and get expert advice before doing so.

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How do I avoid this?

There are a variety of ways you can avoid paying these fees, or at least a part of them. Really it all depends on the form of borrowing you've decided on, as some of these will be specific to the loan type. Usually, the bank will not let you out of the fee unless it's in their interest. Therefore you should compare loans to see if there are some without fees for repaying them early.

• The most simple way to avoid these charges is to choose a loan deal that specifically does not have them. They are harder to come by but can save you money if you think you will be able to pay it off early
• If you are trying to pay off your current mortgage in order to move home you can ‘port' it. This means that they can apply the same loan interest rate to the new property. Essentially this is transferring your original mortgage from one property to another, this is a very good option but not always available.
• There is often a ‘charge free' amount where you can pay back a certain amount of the loan before you are charged. If your current loan is a mortgage you can typically pay up to 10% before you'll be charged