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- Pryor on property: news and views Why charge redemption penalties at all?
Redemption penalties can be the sting in the tail of an otherwise attractive mortgage offer. Headline rates tend to grab the attention and, in the flush of enthusiasm that can follow from securing that perfect product, insufficient attention to detail might be paid to any penalty that will be incurred if the loan is repaid prematurely.
The consumer lobby, as might be expected, hates redemption penalties with a passion, claiming they are nothing more than cruel shackles on house-buyers freedom of movement.
But the logic behind imposing them is clear: the twin pressures of competition and consumer demand have obliged lenders to offer products at rates which bring in less revenue than it costs them to secure funds in the first place.
In order to balance the books, they need borrowers to remain with them throughout incentive period and sometimes beyond. The job of the penalty is therefore to persuade the borrower to stay put or simply to recoup the necessary funds.
Can they not just be abolished altogether?
To abolish penalties totally, would merely serve to narrow borrowers choice, as some borrowers are happy to take a product with a penalty to obtain a rate which helps with monthly cashflow or a rate that enables them to get a foothold on the property ladder. So penalties do have their uses.
The point about securing the borrower's business on a variable rate once the offer period has finished is a particularly ticklish one, and once again the consumerists have been eager to criticise redemption penalties which persist even when the loan has reverted to variable terms.
This pressure would seem to have been effective, since the number of mortgages offered with an 'over-hanging' penalty clause appears to be reducing. The whole issue of redemption penalties has arisen because mortgage lenders have become more creative in the way they structure loans.
Fixes, caps, collars, trackers and deep discounts have been brought into play as a way of attracting custom, with penalties in effect being used to underwrite marketing flights of fancy.
But the process is inevitably self-perpetuating: as competitive pressures continue to mount, lenders desperately seek new ways to distinguish themselves from the pack. This means there is a steady stream of attractive mortgage offers coming onto the market, and yesterday's bird of paradise can soon become today's prize turkey.
Borrowers, naturally, want the best deal they can lay their hands on, so there is increased restlessness, with house-buyers willing to change lender in order to secure more advantageous terms. Indeed, they are encouraged to do so with cash-back offers. So redemption penalties are employed in turn to prevent the sort of movement that is the inevitable consequence of marketing activity.
Advice
Advisers may smile - or grimace - at the irony of the situation, but it certainly means they have to assist clients who are considering moving to a seemingly more attractive deal but who will have to pay to get out of their existing arrangement.
Needless to say, great care will need to be exercised with regard to the calculations that will accompany this process regarding whether the move is financially worthwhile or not. It is not only the sudden appearance of a competitive offer that triggers movement by borrowers.
If there is a marked downward shift in interest rates, then a lot of fixed rate offers will soon lose their appeal and borrowers will itch to escape from products that are not even competitive compared to the latest, penalty-free variable rate offers. Whatever type of rate the adviser and the client decide to go for, consideration should be given to the lender's redemption fee strategy.
At one end of the scale, there are a few, mainly short term, fixed-rate loans that have no redemption fee whatsoever. Then there are longer-term loans, which have a reducing scale of penalty charges, thus providing increasingly less painful exit routes if general economic circumstances make a move more attractive.
Offers with hefty fees running up to the end of the fixed rate period or even beyond should perhaps be given the widest berth.
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