Redemption Penalty

Once upon a time, there was no such thing as a redemption penalty. Borrowers stayed with the same mortgage lender for life, happily paying the lenders Standard Variable Rate. If they wanted to repay all or part of their mortgage, move to another lender, or simply pay more each month, they were free to do so WITHOUT PENALTY. 

As competition between lenders grew, they began to offer mortgages that were discounted for an initial period, or fixed.

Not so common now, but very common during the 1990's was the practice of extended redemption penalties. Usually applied to discounted mortgages, but also to every other type of deal.

Lenders vie to be "top of the tables" for cheapest rates. As a lender, if you can undercut the cheapest discounted rates offered by your market competitors, then you are likely to secure more business. However, your profit margins may be cut to unnacceptably slim levels. One method of offering cheap rates, whilst at the same time maintaining profitability, is the use of extended redemption penalties.

Extended Redemption Penalties are redemption penalties which extend beyond term of the deal being offered. The borrower then becomes trapped on the lenders Standard Variable Rate for a couple of years, sometimes much longer.

The cashback mortgage, once extremely popular generally worked on the basis of a 5% cashback, with a 5 year redemption penalty of 5% of the loan. Meaning that the borrower had to pay the lenders Standard Variable Rate for the next five years. This was taken to extremes by the Cumberland Building Society, who had a 7 year tie in.