Beware the high cost of low mortgage rates

Published 06th Oct 2010

Many low interest rate mortgages are rendered useless by high fees.


Andrea Lowe from Lincolnshire took out an offset mortgage with First Direct two years ago and is pleased to be paying just 1.49pc – especially as she didn't have to pay a fee.

Borrowers are often charged higher fees for the best offsets, brokers said, but there was none on Ms Lowe's loan, which charges 0.99pc plus Bank Rate for the life of the mortgage.


Ms Lowe said she was really pleased with her loan. "Our outgoings have fallen as a result of the low rate and our offsetting savings," she said. Financial providers can be sneaky fellows and they will rarely let the small print get in the way of a marketing wheeze.

Take mortgage lenders, for instance. They frequently use the carrot of rock-bottom rates to entice borrowers to get a fix or a tracker loan. Rates are important, but if you fail to check the finer details you could end up paying thousands of pounds more than you need.

In the distant past an arrangement fee used to be fairly bog-standard across the board, nothing more than a couple of hundred pounds. But in recent years, borrowers have been charged up to £2,000 simply to secure the deal. Some fees are calculated as a percentage of the loan equating to fees up to as much as £5,000.

If you want the best deal, there is really no alternative to getting out your calculator and working out the total cost of the loan, including interest and fees – although you could always get a mortgage broker to do the work for you.

A seemingly unbeatable fixed-rate mortgage from Principality Building Society illustrates the point. The interest rate on the two-year deal, 2.24pc, is the lowest on the market, according to Moneysupermarket.com, the price comparison service.

But someone borrowing £150,000 will find that this loan costs them about £3,000 more than a low-fee loan over the two years because Principality's mortgage comes with a 3pc fee.

The borrower would be better off with a two-year fix from HSBC, even though the interest rate charged is 2.89pc – 0.65 of a percentage point more than on the Principality deal. This is because HSBC charges a flat fee of £99 on its home loan. The total cost of HSBC's mortgage over the two-year term is £17,117, moneysupermarket.com calculated, whereas the total cost of the Principality loan is £20,303, a difference of £3,186. When Principality's product is compared with a two-year fix from ING Direct, on which the interest rate is 2.79pc and the fee £945, the saving is even more marked, with the ING loan almost £5,000 cheaper over the two‑year period.


WHEN IT'S WORTH PAYING A FEE

Sometimes it's worth paying a higher fee in order to qualify for a low interest rate. For example, Principality offers borrowers the option of a two-year fix with no fee at an interest rate of 3.49pc.

The total cost of this deal for a loan of £250,000 over the two years is £30,005, according to London & Country, the mortgage broker. But you could save £326 by opting for a two-year fix from ING charging 3.09pc interest, even though there is a fee of £945. (This ING loan is more expensive than the previous one as it is available to borrowers with a 25pc deposit; a 40pc deposit is needed to qualify for the 2.79pc deal.)

It's the opposite story for smaller loans, however. If you want to borrow £120,000 rather than £250,000, Principality's deal is the cheaper of the two. Its loan would cost £14,402 over the two years, a saving of £336 compared with the £14,738 cost of ING's mortgage.

These examples illustrate two rules of navigating the mortgage fees issue. First, it's not as simple as saying fees are good or bad - you have to compare the total cost of the various loans. Second, the larger the amount borrowed, the less important the fee. This does not apply to fees that are a percentage of the loan, however.

"For a small loan it's better to go for a low or zero fee, but for larger amounts a higher fee may be worth paying to get a low rate," said David Hollingworth of London & Country. "However, the impact of percentage fees doesn't diminish as the loan gets bigger, so it's very rare that we would recommend this type of mortgage. You'd only choose them if the need to minimise monthly payments was paramount."

A 2pc fee in effect increases the interest rate you pay by one percentage point on a two-year deal, Mr Hollingworth pointed out.

Clare Francis of moneysupermarket.com said: "Charging high fees enables lenders to showcase extremely low rates without missing out on profit and it's clear that some of the current best buy products have been released for marketing impact, rather than real borrower benefit.

"The key when looking around for a mortgage is to calculate the total cost over the term of the deal."

Comparing the total cost of different mortgages over a particular period is not quite as simple as multiplying the monthly payments by the number of months and adding the fee – although this will give a good approximation – because of the effect of repayments of capital.

A number of tools to calculate total costs are available on the internet, such as one at www.tinyurl.com/38e8yn8; alternatively, a mortgage broker will crunch the numbers for you – but remember that some of the best deals are available only directly from lenders, not through intermediaries.


THE HIGHS AND THE LOWS

You might think that mortgage deals with low interest rates would always carry high fees, but this is not the case, according to Melanie Bien of Private Finance, the broker.

As an example of a loan with a low rate and a low fee, she pointed to a two-year tracker from Darlington Building Society charging 2.75pc interest and a £499 arrangement fee. Accord, part of Yorkshire Building Society, had "competitive" rates and a standard arrangement fee of £995, Ms Bien added.

Mr Hollingworth liked HSBC's five-year fix at 3.94pc and lifetime tracker charging 1.69pc plus Bank Rate as the fee in both cases is just £99.

Ms Bien said "bad deals" included mortgages offering "headline-grabbing" rates but with 2pc arrangement fees from Alliance & Leicester and The Mortgage Works, a subsidiary of Nationwide Building Society. Other high fees on the market include £1,995 on some loans from Santander.


HOW LONG IS YOUR LOAN?

A £1,000 fee has a far larger effect on the total cost of a two-year fix, assuming that you remortgage when the deal expires, than on a five-year fix or a lifetime rate.

"The longer the period of the loan, the longer the time you spread the fee over, so it may be sensible to pay a higher fee for, say five-year deals," Mr Hollingworth said.

Source: ' Telegraph '

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