When a low headline rate could cost you dear
By Damian Clarkson     09th January 2008

Choosing a mortgage simply on the headline rate could mean that you end up paying far more than you need to, thanks to the huge increase in the size of mortgage arrangement fees.

Mortgage lenders have realised that most people tend to focus solely on the rate, and so advertise juicy low offers but then plump up the costs in less visible areas – like arrangement fees.

As an indication of how far this process has come, mortgage arrangement fees cost as little as £299 in 2005, but, in November last year, Abbey tacked a fee of £9,999 onto one of its higher-value mortgage products.

As if it wasn’t confusing enough for the mortgage hunter having to choose between a fixed, discount, offset, capped, or tracker mortgage, now you have to work out complex cost versus rate calculations as well. The good news is that we are able to give some easy-to-use rules of thumb to make the job easier.

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How to know which mortgage is best for you?
So how do you know what mortgage will work for your individual circumstances? The basic principle is this: For large mortgages the headline rate is vital and the fee less so, while for smaller mortgages the size of the fee becomes more important.

To illustrate this point, we compared three different two-year fixed rate mortgages: One with a low rate but a high fee, (First Direct), one with both and average rate and fee (Alliance & Leicester) and one with a high rate but low fee (Halifax).

In our first scenario, we looked at the cost of a large £200,000 mortgage to be repaid over 20 years. As the table below shows, First Direct’s low rate deal is comfortably the cheapest despite the hefty £1,498 fee, costing a total of £33,149 after two years. Conversely, the high rate on the Halifax deal pushes the cost up to £35,695, or £2,546 more expensive.

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£200,000 mortgage over 20 years

	Rate	Fee	1st Year Cost	2nd Year Cost
First Direct	4.99%	£1,498	£17,323	£33,149
Alliance & Leicester	5.73%	£999	£17,821	£34,644
Halifax	6.29%	£499	£18,097	£35,695

In our next scenario, we took the same three products but applied them to a £100,000 loan. Once again the First Direct deal is cheapest, followed by A&L and then Halifax, but the figures are far closer this time –just £774 difference between all three.

This illustrates that the high fee at First Direct is now starting to eat into the advantages offered by the low rate.

£100,000 mortgage over 20 years

	Rate	Fee	1st Year Cost	2nd Year Cost
First Direct	4.99%	£1,498	£9,410	£17,323
Alliance & Leicester	5.73%	£999	£9,410	£17,821
Halifax	6.29%	£499	£9,298	£18,097

In our final scenario, we looked at how the three deals would compare on a smaller £50,000 mortgage.

As the table shows, it is now the Halifax product which is cheapest at £9,298, despite having a significantly higher rate than that of First Direct.

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£50,000 mortgage over 20 years

	Rate	Fee	1st Year Cost	2nd Year Cost
First Direct	4.99%	£1,498	£5,454	£9,410
Alliance & Leicester	5.73%	£999	£4,955	£9,410
Halifax	6.29%	£499	£4,898	£9,298

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Avoid tacking a fee on the loan
If you are looking for a mortgage, many lenders will offer to tack the arrangement fee onto the loan so that you don’t have to pay anything up front. Considering the significant costs homebuyers will have to contend with already – legal fees, furniture removal, stamp duty – this may seem like a tempting offer, but don’t be fooled.

You see the problem is you will then be paying interest on that fee for the entirety of you mortgage – some 20 to 25 years, making it dramatically more expensive.

If you simply don’t have the funds to pay the fee, pay for it instead with a credit card offering a lengthy interest free introductory period on new purchases. The Halifax Purchase card is pretty much the best deal around at the moment, offering 15 months interest free.

So assuming your arrangement fee is £999, all you have to do is pay £66,60 a month onto your credit card and you’ll be rid off that debt without paying any interest.

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MyPropertySpy action points

If you have a large mortgage, the headline rate is vital. For a smaller mortgage, pay close attention to the arrangement fee. Never tack the fee onto your mortgage. If you can’t afford it, pay for it with an interest free credit card.

Article produced by EveryInvestor.co.uk