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Buying a property is an expensive business. So if your lender offered a fee-free mortgage, would you be tempted? If the answer is yes, you’re not alone.
The Bank of England included a striking chart in its regular report on financial stability this week. It showed that the proportion of new mortgages which carried no arrangement or booking fee had risen from around 12 per cent in 2012 to nearly 50 per cent in the year to date. That is an awful lot of mortgages cut loose from the decades-old tradition of these one-off transaction charges, which can cost some buyers thousands of pounds.
The Bank thinks the trend is evidence that the cost of borrowing is falling. So good news, apparently, for first-time buyers and movers looking for a new home loan.
A more plausible explanation is that the growing constraints on affordability and rises in the fixed costs of buying are pushing people towards the fee-free option. If you are stretching yourself to put down a deposit or struggling to find the cash for stamp duty and legal costs, why not take what you can get when a lender offers to waive the booking fee?
As interest rates start to creep up from their historic lows following last month’s base rate rise — the first in more than a decade — we can hardly be surprised if the trend accelerates as people attempt to minimise their outgoings. But borrowers would be wise to delve deeper into the overall costs of a home loan. What they find might surprise them.
Those seeking a new mortgage often look first at the best-buy tables produced by comparison websites, which favour mortgages boasting the lowest interest rates. Here, the conventional advice has been that great-looking rates are usually accompanied by steep fees.
But the mortgage lenders are in business to make profits, so the alternative — a fee-free mortgage — typically carries a higher fixed interest rate than its fee-based equivalent. But that doesn’t mean the two are equivalent in terms of overall costs to the borrower.
The size of your mortgage is a key factor. If your borrowings are relatively modest, say £100,000 on a low two-year fixed rate mortgage with a deposit of 25 per cent, it will nearly always make sense to take the fee-free option, since the effect of paying potentially thousands of pounds in fees every two years when you remortgage can quickly wipe out the advantage of the low rate.
Imagine you are considering two deals on the mortgage above: one at 1.29 per cent carrying a fee of £995; and another at 1.69 per cent, with no fee. Which offers better value?
The former wins hands down on headline rates, with a 0.4 percentage point advantage. Over two years, a borrower would pay £2,580 in interest compared to £3,380 on the second deal. But throw in the fee, and the total cost of the first deal rises to £3,575. With no added extras, the second fee-free deal is clearly the cheaper option.
It doesn’t always work out like this, however. Do the same calculation for a bigger mortgage of £300,000. With a 1.29 per cent rate, interest costs over two years come to £8,735, including the fee. With a 1.69 per cent rate and no fee, they total £10,140. For those borrowing a chunkier sum, it is evidently worth paying the arrangement fee, for a saving of more than £1,400.
Adrian Anderson, director at broker Anderson Harris, says that as a rule of thumb this size-based tipping point lies around the £225,000 mark for a loan-to-value mortgage of 75 per cent on a two-year fix. Longer fixes and other variables may demand a different formula, but the lesson is clear: one cannot draw conclusions about the value of a fee-free deal without comparing it with the overall costs of a cheaper fee-based loan.
The Bank of England figures, which drew on data from finance website Moneyfacts, do not include remortgaging but there is evidence of a similar growing antipathy to fees in that part of the market. One mainstream lender told me that remortgaging activity on its fee-free deals had risen by 60 per cent in the past three months, as people reacted to growing warnings of an interest rate rise by locking in low rates while aiming to curb their transaction costs.
Those deals may well be the most suitable ones. But a few minutes of totting up interest and fees over the length of a fixed-rate loan is time well spent. It might make the difference between an overstretched household and one which can live within its means.