Friday, 27 April 2012

Get a great mortgage for free!

As mortgage fees soar we do the sums on homeloans with no upfront costs.

The average mortgage arrangement fee is now an eye-watering £1,502, and this has rocketed 25% in the past three years alone, according to Moneyfacts.

Such steep fees are extremely difficult for many borrowers to cope with, because they come at a time when money is usually tight and most of your savings have been put towards a deposit and Stamp Duty. So there is often very little left in the pot.

And while the average fee is £1,502, some can rise as high as £3,000 or even more – a figure that seems a little preposterous. How on earth can it cost a lender that much money to arrange a mortgage, when they are in the business of arranging mortgages? Surely they can do it for less?

In fact, the mortgage 'arrangement fee' comes under a few guises, such as a booking fee, administration fee or completion fee. And just to make the whole thing even more confusing it is sometimes split into two separate fees, one of which is non-refundable if the deal falls through.
But whatever it is called, it is probably best not to think of the mortgage fee as something that literally pays for the costs of arranging a mortgage, because the cost isn't really related to that.

It all adds up
Instead it can help to think of the lender constructing an overall deal using different pricing methods – the interest rate, the arrangement fee, and other costs like valuation and legal fees.

It uses all of these pricing mechanisms to come up with a deal. This means mortgages that cost exactly the same overall could have quite different rate and fee permutations. Let's look at a few examples:

Take the two mortgages below – both two-year fixed rates, one charging 3% interest and the other 3.5%.

They will cost a borrower with a typical £150,000 loan exactly the same over the two-year fixed period – £18,024 – even though the monthly repayments are £40 a month more on the higher rate. The fact that the lower rate deal has an arrangement fee means they balance out overall:
  • Fee-free 2-year fixed rate at 3.5%. Monthly payments are £751 which totals £18,024 over two years
  • 2-year fixed rate at 3% with £960 arrangement fee. Monthly payments are £711 which totals £17,064 over two years, plus fee of £960 totals £18,024.
You could argue that this way of pricing mortgages actually gives borrowers more choice. The two deals above cost exactly the same but different borrowers may prefer one over the other.

If you have a large savings pot but a modest income you might prefer to pay the higher fee and keep your monthly repayments low.

However, if you have spent all your savings on your deposit but have a high income the fee-free mortgage might suit you better.

Why size really matters
The pros and cons of choosing a fee-free deal become even more apparent when you start looking at different levels of borrowing. As a rule of thumb, the more you borrow the less important the arrangement fee is to your overall cost, and the less you borrow the more important the fee becomes.

For example, based on the same two mortgage deals, a borrower with a large £300,000 mortgage is better off going for the lower interest rate and paying the £960 arrangement fee. They would save £936 over the two years.

However, a borrower taking out a small mortgage of £100,000 is £312 better off with the fee-free deal, despite having a higher interest rate and therefore higher monthly repayments.

Even though the two deals cost a typical borrower with a £150,000 the same over two years, high value borrowers (£300,000) do better paying the arrangement fee and bagging the better rate, while those with modest borrowings (£100,000) are better with the fee-free option.

Are lenders profiteering?
By showing that a variety of different mortgage fee options can actually give borrowers more choice, I am not defending lenders' price hikes. It is true that they have been quietly inching up their mortgage fees over the last three years. However the same Moneyfacts research that highlights this trend also shows that mortgage rates have fallen over the same period. Of course, with base rate at an all-time low, they should have done!

The main thing to remember is that while you can't affect what lenders are doing with their rates, you can make sure that you get the best deal for your circumstances. And that may not always be the mortgage with the lowest interest rate, nor will it always be a fee-free mortgage.

Lenders generally levy large arrangement fees on their most attractive interest rates, meaning you pay a premium upfront to bag the cheapest ongoing costs. But if you look carefully there are some hidden gems among fee-free mortgages that give you the best of both worlds.
Below are some of the best low-fee and fee-free mortgages available right now:

Fab fee-free deals

Lovely low-fee (£500 and under) mortgages

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