How to compare mortgage products by total cost, not the headline rate alone
A common dilemma when choosing a mortgage is deciding between two types of deal. One may have a lower interest rate with an arrangement fee. The other may have a higher rate with no fee or a smaller fee. Mortgage arrangement fees can change the total cost, so the lowest headline rate is not always the cheapest option.
When I compare products as part of my mortgage services across Cornwall, Devon and the wider UK, I look beyond the headline rate. I consider the fees, mortgage balance, monthly payments and length of the deal. The right choice will depend on your circumstances.
What are mortgage arrangement fees?
A mortgage arrangement fee is a charge paid to the lender for setting up a particular mortgage product. You may also see it called a product fee or completion fee.
Some mortgages have no arrangement fee. Others charge a fixed amount, which may start at around £495 and rise from there. Some lenders, particularly in the buy-to-let market, charge a percentage of the loan. On a large mortgage, this can make the fee several thousand pounds.
The lender may allow you to pay the fee upfront or add it to the mortgage. Before choosing, it is important to understand how each option affects the overall cost.
Is the lowest mortgage rate always cheapest?
No. A lower rate can reduce your monthly payments, but the saving may not always cover the arrangement fee.
A lower rate with a fee and a higher rate without one can sometimes cost roughly the same. In other cases, the fee-free deal may cost less over the fixed or introductory period. With a larger mortgage or a longer deal, the lower rate may save more than the fee costs.
MoneyHelper’s guidance on comparing remortgage deals gives a useful example. The product with the lowest rate costs more once the arrangement fee is added. This shows why the total cost matters more than the rate alone.
What should you compare?
When looking at two mortgage products, consider:
- the monthly repayment;
- the total payments and fees during the initial deal period;
- whether the fee will be paid upfront or added to the mortgage;
- any interest charged on an added fee;
- incentives, other charges and early repayment charges; and
- the mortgage balance left at the end of the deal.
Your mortgage illustration sets out the rate, repayments, fees and overall cost. This helps you compare products on a consistent basis.
Can an arrangement fee affect your LTV?
Adding a fee to the mortgage increases the amount you owe. Is your borrowing close to a loan-to-value, or LTV, boundary? If so, the extra amount could affect the product or rate available. It must also fit the lender’s affordability and maximum LTV rules.
Any fee added to the mortgage stays within the balance until you repay it. You will pay interest on it during that time. Moving to another product at the end of a fixed term does not remove it. An overpayment may reduce the balance, but check the lender’s rules first.
Paying the fee upfront or adding it
Paying mortgage arrangement fees upfront keeps them out of the loan. This avoids paying interest on them. However, check whether the lender will refund the fee if the mortgage does not complete.
Adding the fee can reduce the amount you need to pay at the start. However, it increases the loan balance. Some clients add the fee during the application and then pay it before completion if the lender allows this. The options and refund terms vary between products.
How this works for buy-to-let mortgages
Buy-to-let landlords sometimes choose a higher arrangement fee in return for a lower rate. Why? A lower monthly payment may help them keep more of the rental income after paying the mortgage.
Some lenders use a rental stress test to decide how much they will lend. Depending on the calculation, a lower rate may help the application meet the rental coverage requirements. This can make a lower rate with a higher fee the workable option, although lender criteria vary.
The tax position also needs care. HMRC includes mortgage interest and fees for obtaining or repaying a mortgage within residential property finance costs. For individual residential landlords, tax relief is generally restricted to a basic-rate Income Tax reduction. Companies are treated differently. You can read the current rules in HMRC’s guidance for residential landlords.
Tax treatment depends on your circumstances and how you own the property. I would always suggest speaking to an accountant or tax adviser before making a decision for tax reasons.
Is a fee-free mortgage really free?
Fee-free normally means that the product has no mortgage arrangement fee. It does not mean that the mortgage has no costs. The lender may offer a higher rate, different incentives or other charges.
A fee-free mortgage may offer better value for a smaller mortgage or a shorter deal. It may also suit someone who wants to limit upfront costs. Weigh up all the factors rather than assume that “fee-free” or “lowest rate” automatically means cheapest.
Choosing the right mortgage deal
The best option depends on the full cost. It must also fit your plans. A mortgage adviser can compare the rate, fees, monthly payments and remaining balance rather than looking at one figure alone.
If you are buying, remortgaging or reviewing a buy-to-let mortgage, please contact me for a straightforward conversation. I can compare the options and explain which combination of rate and fees may suit you.
We may charge a fee for mortgage advice. The exact amount will depend on your circumstances, but a typical fee is £350.
Your home may be repossessed if you do not keep up repayments on your mortgage.
Anna Wilson Mortgage Services is a trading name of Monster Insurance Services Ltd and is registered in England and Wales at: 71–75 Shelton Street, Covent Garden, London, WC2H 9JQ. Registered in England No. 9864526. Authorised and regulated by the Financial Conduct Authority.
