Early redemption penalties have become an increasingly common feature of most mortgages over recent years. So, why are lenders imposing them and should you be worried about them?

The mortgage market in the UK has become very aggressive with every lender fighting to retain their market share and capture business from their competitors. In many ways this is good for the consumer but there are also some disadvantages. Whilst most lenders are happy to compete for new customers, much of the time this seems to be at the expense of their existing customers. This has lead to the crazy situation where you can usually get a better deal by re-mortgaging to a competitor than your existing lender will be prepared to offer. The mortgage market has become so competitive that many of the products on offer are put out as 'loss-leaders' to attract new business. As a result of this the lender needs to retain your business for a number of years to have any chance of making a profit from the transaction. The way that most lenders now do this is to impose heavy penalties if you wish to repay the mortgage within a certain number of years. These penalties can range from one month's interest right up to 12 month's interest in severe cases.

Should these penalties concern you then?

Well, yes they should. If you are tied to a particular lender for a period of time you have basically lost the right to shop around for the best deal. Particularly worrying are deals that will give you a fixed or discounted rate for a number of years but then tie you into the lender at the end of the initial fixed or discounted period. This is now becoming the norm rather than the exception but there are also a number of products that leave you free to move on at the end of the initial period.

What you should remember is that the best rates will almost invariably contain the harshest penalty terms. Whilst you will obtain a good saving during the initial fixed or discounted period you will then have a period of time when you will be tied to the lenders standard variable rate. It is sometimes more beneficial in the long term to accept an interest rate that is not quite as attractive as the best in the market but which allows you to re-mortgage again at the end of the initial period. In this way you can hopefully make a further saving at that point. It is also worth looking out for products that will guarantee to offer you another fixed rate at the end of the first fixed rate period. If you can find a product like this which has no redemption penalties at the end of the initial period then you should be reasonably safe in assuming that the subsequent fixed rate offer will be attractive as otherwise the lender would be in danger of losing your custom.

Are there any ways of avoiding these penalties altogether then?

There are now a number of lenders that specialise in offering straightforward variable rate mortgages with none of the catches associated with the more aggressive products. Many of these companies are the new breed of direct telephone style lenders and they try to offer a permanently competitive variable rate with none of the frills attached to some of the other products. These products are covered in more detail in the next chapter when we talk about the new Flexible Current Account/Lifestyle type of product.