If you’re choosing a new mortgage, it’s easy to head online or to a newspaper ‘best buy’ table to scan the lowest rates that are available. Finding a low-cost fixed or discounted rate is simple, and with thousands of products to choose from it’s not tough to get a cheap deal.
However, the lowest interest rate may not be the cheapest or the best deal for you. That’s because many of the market-leading rates come with substantial arrangement fees, and these charges can eat into the savings you make.
In our guide, we look at why it’s important to consider both the interest rate and the fees when you’re choosing a mortgage. Keep reading to find out more.
Choosing the lowest interest rate could cost you £900
When trying to win new business, mortgage lenders often compete purely in terms of headline interest rate. By doing this, banks and building societies appear at the top of ‘best buy’ tables, meaning their products sit among the cheapest products on the market – making them more appealing to borrowers.
Clare Francis of moneysupermarket.com says: "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.”
However, as ‘best buy’ tables are ordered by interest rate, many of these products have substantial arrangement fees attached. Indeed, research from a leading online mortgage broker has found that the ‘cheapest’ mortgage deals could now end up costing borrowers an additional £900.
The study shows that many borrowers would actually benefit financially by choosing a higher interest rate in order to pay a lower fee.
For example, at Nationwide Building Society, the lowest two-year fixed rate of 1.54% would cost you £14,213 over the first two years when fees and other charges are considered. However, you could save £874 by choosing a loan from the same lender with a higher interest rate but lower fees.
This is also the case at rival lenders. At Santander, you could save £811 by choosing a mortgage with a higher interest rate but lower fees. You could make similar savings at banks including Barclays, HSBC and NatWest.
Read more about mortgage fees and costs.
Paying a higher rate can work out cheaper
Research by financial analysts Moneyfacts in 2017 found that the average fixed-rate mortgage arrangement fee has reached a four-year high. The average fixed-rate fee is now £1,018, up from £886 just three years previously.
Charlotte Nelson from Moneyfacts says: “Some of the lowest deals on the market have fees of around £2,000, and some borrowers are being asked for even more, with the largest fee on a fixed rate mortgage sitting just shy of £4,000 (on a deal for professionals only)."
While choosing a lower interest rate may reduce your monthly repayments it can increase your overall cost, as we have seen. There are two main reasons for this.
Firstly, on smaller mortgages a large arrangement fee can have a greater impact on the overall cost. Choosing a lower interest rate may save you a small amount on your monthly repayments, but it perhaps won’t save you enough to justify the larger arrangement fee.
On larger mortgages, however, it can pay to choose a lower rate with a higher fee. The savings that you can make on your monthly repayment will often outweigh the charge, and so it can be financially beneficial to choose a rate with a larger fee.
It may also be sensible to consider higher fees on longer term products. A £1,995 fee on a two-year fixed-rate adds almost £1,000 a year to the cost of your mortgage. The same fee on a five-year deal may work out more cost-effective as you spread the fee over a longer period.
Many mortgages also let you add the arrangement fee to the mortgage, so you may not have to pay the charge upfront.
However, bear in mind that this does increase the amount you are borrowing. This, in turn, pushes up your monthly repayments and could negate the lower rate you are getting when compared to a fee-free deal. You will also potentially pay interest on the arrangement fee for the entire term of the mortgage, which could be 25 years or more.
Charlotte adds that: "A low rate with a high fee does tend to favour those borrowers purchasing properties at the higher end of the housing market, so the advantages of a fee-paying versus a fee-free product will depend on personal circumstances."
Seek professional advice to find the right deal for you
Finding the right blend of fees and charges for your circumstances can be tricky. Earlier this year, the Financial Conduct Authority, warned that around 30% of borrowers failed to find the cheapest mortgage for their circumstances.
The Daily Telegraph reported that failing to find the cheapest deal cost these borrowers an additional £550 per year on average.
If you’re unsure which rate to choose, seeking professional advice can help. A mortgage broker will be able to cost up some alternatives for you, taking into account both the monthly repayments and the arrangement fees.
Mortgage expert David Hollingworth says: “Big fees can work for those with bigger mortgages, where the lower rate will outweigh the additional set-up cost. But for many a better balance of fee and rate will be the best value. Most lenders will offer a range of options and fee/rate combinations, so digging deeper should mean that there’s a loan that’s right for the individual.
"It’s therefore better to look at overall cost rather than focus entirely on the monthly payment."