Given the current statistical bonuses, I don't think this would even matter.  The strength penalty would be of importance to trained melee units, inconsequential to champions (unless they start using multiple attacks). The move penalty would only make a difference if you removed traits like 'fast' and 'charge'. Champions again would be largely unaffected because they would just ride horses. Even if you removed fast and charge, units could give up the foot armor for magic boots.

The initiative would only make a difference if they neutered the  bonuses to initiative from city defense and haste.

Currently there is no simple fix to this. The current values of spells, traits and items all need some serious adjustments for encumbrance to matter, or the ammounts need to be so high that doing so will root most low tech units to the ground (which probably isn't the intent). An adjustment to the way a few systems work might help. Accuracy and dodge are pretty quirky, my suggestion would be to start there, and maybe add a few tiers to encumbrance. Perhaps I shall make a post about it later.

And it's possible to get up to +9 strength for units with trait selection - Rage, Muscle and Strength.  Which means you can easily get a regular unit into low encumbrance, especially with a horse.  I don't see why a trait called "Rage" would give added carrying capacity.

Harsher encumbrance limits just forces everyone into str. What's the point? Everyone already maxes str for damage and defense.

Not if dodge would be an alternate path, but currently accuracy scales with the level, but dodge does not and that is a huge problem.

  The design is that armor is heavy and increases encumbrance.  The higher your encumbrance the slower for initiative (currently the range is from -1 to -3) and can reduce the units movement (by 1).

  Trained units for most races will have a hard time wearing heavy armor and weapons unless some traits are spent on increasing strength further increasing the cost and training time even more than the armor alone did.  Archers are welcome to spend their traits on strength so that they can wear heavy armor, but those are traits that aren't making them better archers.  Its a valid choice, heavy armor on your strong archers is fine if that is what you want.  But there are strategic costs to it (it will reduce their init, making them attack less frequently, use your metal supplies, increase their training time and use some of their traits).

  The theory is the same with champions.  The reason the path of the warrior and defender boost strength is to allow those champions to use heavier armor and weapons that path of the assassin and especially mage will have problems doing.  Again you can take path of the mage, throw on some strength enhancing magic items or spend traits on it (though there is only 2 small ones for path of the mage) and have your heavy armor mage, but its rare and requires some sacrifice (ie: that gear may be better on melee champions, those traits may be better spent reducing tactical spell cost or increasing spell damage).

  The above is the way it is "supposed" to work.  But it needs a tighter balance.

  In response to the OP here are the design principles we are shooting for:

1. Leather armor isnt "better" than plate armor.  It is cheaper both in training time and resource costs.  It is available to more units.  But it isn't intended to be "better" than plate for some units.  If we made it better we take the choice out of unit design and we enter into a situation where you should use armor a with unit type a, armor b with unit type b, etc.  And we have less real options than we do now.

2. Leather increases dex would be weird (im more agile when im wearing leather armor than when im wearing no armor?).  But im cool with applying dex penalties at higher encumbrance levels (so units with heavy armor wont dodge or crit as often).

3. I think we can do more with traits that impose encumbrance penalties.  We can have a trait that gives +10 init in the first round of combat but lowers the units encumbrance by 10 (ie: you have to stay lightly equipped but you get to go first).  I wouldn't mind some free traits (ie: no training time cost) whose only cost is they take up a training slot and mess with encumbrance.

4. As I mentioned above we need some balancing to make the designed options feel like options.  If players dont feel like their is a significant disadvantage to outfitting their archers with plate mail in a normal game then we have work to do (metal may be to easy to get, training time on plate may be to small, strength is to high, traits are to good or later isnt heavy enough.

Thanks a ton for the detailed response Derek!

This is a valid point, although I don't feel there is a ton of choice in a knapsack problem. I also disagree that there will be automatic choices if we provide reasons to actively choose leather over plate. For example, it would make sense for a warrior in leather or no armor to be more agile and able to deal more damage than one in plate. Right now, they deal the same damage, but one is simply cheaper than the other.

Part of this issue is brought about because strength is tied directly into both encumbrance and damage (as heavenfall pointed out), so there's no choice there. Dark souls uses an "Endurance" stat to determine how much it can carry, and it might be a good idea to do the same here. Then there might be some choice between armor and damage.

I meant to point out that clothing or robes would give bonuses as well, but that's more work. The math will end up working the same with bonuses as with penalties, so I agree with this. It also makes a lot of intuitive sense. Further, if there ends up being some sort of an endurance trait, maybe encumbrance can lower "strength" as well? It makes sense too. If you're encumbered you're not going to be able to swing an axe with as much force. 

This is a good idea as long as the traits that lower encumbrance are kept under control. Encumbrance never seemed to be an issue for any of my units or champions, but for all melee units I tend to put my points into strength since it's mostly a no-brainer. I think you are address this in your fourth point as well .

In regards to champions: Right now there is a sense of homogeny to champions that is bad for the atmosphere and replayability of the game. All champions, mage or warrior, use the best weapons and armor available. Everyone looks the same. I have not had any issues putting the biggest weapons and heaviest armor on all of my champion units. It also seems that the AI does the same. I don't think I picked strength bonuses for my mages, but I may have. Does strength naturally increase over time? If so maybe it shouldn't. Or maybe the "endurance" stat shouldn't.

Also, consider more bonuses and super awesome MAGICAL items for champions only. Leather that increases dex or critical chance would make sense if it were limited to champions, and it would help mix things up with armor and aramaments as well.

Perhaps constitution should affect encumbrance instead of strength, so that is a choice of attack versus defense (str vs con) instead of both at the same time. Alternatively encumbrance should be a -static- ammount, only adjustable by traits. This makes significantly more sense and makes it far less likely that units that don't benefit from increased defense won't be wearing heavy armors (including champions).

Horses shouldn't give an encumbrance bonus, or encumbrance should affect them a different way (you lose move and dodge). The former seems easier to implement though.

Horses should be best when charging into melee, getting flanking bonuses to melee units who are already engaged or ranged or undefended mage units.  If they get "stuck" starting a round already in melee, they should get horrible initiative, dodge, and accuracy penalties.

As far as Constitution affecting encumbrance, that would be much better than strength.  Traits only would be great too.  Or both.  But whatever the choice may be, the encumbrance system definitely needs an overhaul.

Instead of initiative and movement penalties i would use the following penalties if accuracy, dodge, spell mastery and spell resistance scale with the level, because initiative and movement modifications should be rare and without the scaling penalties would be pointless at higher levels.

No encumbrance (1 - 25 %): no modifications

Light encumbrance (26 - 50 %): accuracy - 1, dodge - 1, spell mastery - 1

Medium encumbrance (51 - 75 %): accuracy - 2, dodge - 2, spell mastery - 2

Heavy encumbrance (76 - 100 %): accuracy - 3, dodge - 3, spell mastery - 3

I think the options to decrease the metal in the game or increase the training time are bad, because they make not much sense in the game world (metal weapons do not need metal but metal armor do) and delay only the problem.

The problem seems to be that only regular troops will ever suffer from encumbrance. No matter what stat you use to define it, heroes will be getting alot of it from leveling. Regulars don't get these bonuses and can't change gear. They are the only ones affected. Mounts make it even less important. The fundamental question is what is this mechanic supposed to be doing? On a heroic level, it is supposed to give heavy armor to defenders and warriors, while making it harder to do so for mages and assassins. 

Derek's third response to the OP will make things better, but as an archer hero, I will always need a higher strength to do better damage. As I level, why would I not take every strength option I see? The side effect of this is that I am now able to wear heavy plate with no penalty. Add to that a horse for only 100 gildar and even a low level archer becomes very proficient in rare and powerful platemail. 

I am more inclined to post the problem and let Derek create the solution:

-Mounts muck up the armor system. 100 gildar = Battlemage?

-Strength is so valuable, Assassins will be heavily armored. Hero Archers will also have this. 

-There is no rare leather armor, leaving every type of hero to want platemail.

-High Damage = High Carrying Capacity but High Defense (Con) != High Carrying Capacity, which means all tanking heroes will also have great attacks.

-Mages have little access to magical robes.

You are correct. I forgot about that.

Edit: They should probably be getting some extra attack damage from Dexterity then. 

Isn't this the same kind of weird as with the current weapon initiative bonus? Why am I faster when wielding a sword or dagger compared to wielding no weapon?

And on the same notice: why does the wepon influence the speed of non weapon related actions like walking and spellcasting?