Early repayment charges (ERCs) apply to lifetime mortgages (the most popular type of equity release plan) and they are based on either the prevailing gilt rate or the latest plans now come with fixed term early repayments charges, making it possible to repay your equity release plan, penalty free, at some point in the future.
Read on to discover how ERCs work and how they could affect your equity release plan.
Lifetime mortgages have traditionally been designed for life
Lifetime mortgages offer fixed rates of interest, as do some residential mortgages, with the significant difference being that lifetime mortgages come with fixed interest rates for life. This gives you peace of mind of knowing what the interest payable will be both now, and in the years to come.
Another commonality is that if you want to fully repay and redeem a lifetime mortgage, then an ERC may be payable dependent upon the circumstances. Lifetime mortgages are designed to run for life and lenders cost their plans accordingly. Therefore, if a plan is redeemed earlier than anticipated, the lender could lose out financially and may need to recover this loss.
The ERC is calculated to recover costs that the provider incurs when setting up the lifetime mortgage and not for them to make a profit.
How gilt based ERCs work
Having started my equity release career at Norwich Union (now Aviva) I have first-hand experience of how variable (gilt-based) ERCs operate. We currently have four lenders offering gilt-based ERCs – Aviva, Just Retirement, Legal General and Pure.
Aviva allocate a single gilt to any new plan, dependent upon the age of the individual. For instance, someone age 65 taking a plan may be allocated the 4.35% Treasury Gilt 2039. The yield of the plan is noted on the day the new lifetime mortgage starts.
Should the plan be redeemed early and a penalty due, Aviva would check the that gilt yield on the day of redemption and in accordance with its ERC schedule (provided at inception) could charge a penalty up to 25% of the initial loan. This is dependent upon how far the gilt yield has fallen. Conversely, if the gilt yield has remained the same, or increased since inception, then no penalty is levied.
The other lenders offering gilt based ERCs work on a similar basis, however they use the FTSE UK Gilt 15-Year Index to measure their penalty. Again, they will mark the starting point of the index and see how it changes over the period to early repayment. The greater the fall, the higher the penalty becomes. These lenders such Legal General can again charge up to 25% of the amount drawn.
Therefore, the size of gilt-based ERCs can look onerous and run for the lifetime of the plan.
With lifetime mortgages becoming increasingly flexible, there are now situations where if a gilt-based plan be repaid early, no ERC applies. This varies between lenders, however some of the features available to mitigate ERCs on early repayment are:
- Downsizing Protection – applies when moving home and after a period of time (usually 3 or 5 years) you can repay the lifetime mortgage with no penalty
- 3-Year ERC Exemption – on joint plans, after the first person dies or moves into care the survivor has a 3-year window in which they can repay the lifetime mortgage with no penalty
- Voluntary payments – some lenders allow the full repayment of their plans using voluntary payments of up to 40% p.a. and allow you to pay it down to zero with no penalty
Finally, always bear in mind there are no ERC’s when the plan is eventually repaid on death or second death if it is joint plan, or the survivor moving into long term care residential for all lifetime mortgages.
How fixed term ERCs work
More recently, fixed term ERCs have started dominating the market and brought a simpler way of calculating ERCs which have been brought over from the traditional mortgage market. Therefore, instead of a variable penalty, fixed ERCs offer a defined percentage which lasts for a period of time, the shortest of which is currently 8-years. Knowing in advance what an ERC could be, for many, offers more guarantee and with rates so low currently has attracted more shorter-term borrowers.
For example, Pure Retirement is currently offering their ‘Classic Super Lite’ plan with a fixed interest rate for life of just 2.35% APR and it comes with fixed ERCs that start at 10%, reducing by 1% per annum to year 10. The ERC remains at 1% to year 15, after which the plan can be fully repaid – penalty free. (Correct as 5th November 2020.)
There are many other plans that offer different structures of fixed ERCs and you can compare all the latest deals here. If you are researching equity release and ERCs are a consideration, then please speak to your local Equity Release Supermarket adviser, who will be able to answer all your questions and find a plan that meets your needs both now and in the future.