What’s the true cost of your mortgage?
Since the credit crunch hit in mid-2007, first-time buyers and those looking to remortgage or move up the ladder have struggled to be approved for a mortgage. For those lucky enough to qualify for a loan, the interest they’ll pay has taken on increasing importance.
However, unlike savings accounts and credit cards, comparing mortgage deals by looking at rate alone simply is not good enough. If you buy a mortgage through an independent broker, they will look at a variety of factors – including your personal circumstances and even the type of property you intend to buy – to select the right loan for you.
When you are comparing products yourself online, don’t be tempted to scroll down the list of lenders looking for the one with the lowest headline rate. Apart from the fact that different lenders use different criteria to select (and reject) borrowers, there are a number of expenses to take into account that can significantly add to the total cost of a mortgage.
You need to compare all the charges as well as the interest rates on offer to find the most suitable mortgage deal for you.
The first big cost to consider is the arrangement fee, sometimes known as an application or booking fee. This is usually a flat amount but can also be a percentage-based charge. Some deals require you to pay all or part of this cost upfront, while others allow you to defer the cost until completion and may even permit you to add it on to the loan.
Some deals don’t carry any arrangement fee at all; while you will have to pay a higher interest rate in return, people only borrowing a small amount this could benefit from this type of deal.
In addition, some lenders will offer two different versions of what is effectively the same mortgage – one with a lower interest rate in exchange for a higher fee, and the other with a higher interest rate and a smaller fee.
The arrangement fee can significantly change the competitiveness of the mortgage in question. For many people, deciding whether to go for a low fee and a higher rate, or a higher fee with a lower rate, will come down to their finances at the time they apply for the mortgage and whether they can afford to pay a larger fee.
However, the amount you are borrowing can also determine the best deal for you. David Hollingworth, mortgage specialist at London & Country, says people borrowing a small amount might be best going for a low fee and a higher interest rate.
This is because the bigger the mortgage, the bigger your interest payments will be, whereas an application fee tends to be a flat cost so will have a bigger impact on smaller amounts.
Another charge to take into account is the valuation fee. This is the charge levied by the lender to make a valuation on your property, and you’ll pay it even if you don’t end up taking out the mortgage on offer.
Bear in mind that this is just a basic valuation done for the lender’s benefit – if you are purchasing a property then it’s probably worth paying extra for a Homebuyer’s report or even a full structural survey. You can usually ask your lender to get its valuer to carry out these extra surveys on your behalf.
If you are applying for a remortgage, then you may be offered a free valuation. Bear in mind that the lender will still need to carry out a valuation, so this might be priced into the cost of the mortgage.
Legal fees should also be taken into account when applying for a remortgage. Switching from one lender to another will require some legal work; you may have to pay this yourself or your new lender might offer you a free package.
However, this freebie will only cover basic legal work so if your circumstances are more complicated (for example, you are adding someone else’s name onto the property’s deeds) you may have to pay extra.
For purchases, the cost of legal fees should be taken into account as part of your overall budgeting costs. However, the cost is likely to remain the same whichever mortgage deal you go with, so it probably isn’t relevant when comparing the true cost of different mortgage deals.
One point worth considering, however, is cashback. Some lenders will offer you a monetary amount when your purchase completes, and while this might only be a few hundred pounds, Hollingworth says it shouldn’t be overlooked.
“This cost can be used to offset your other expenses, and should be taken into consideration when assessing the overall value of a mortgage,” he explains.
You should also find out if your lender has any small administration fees such as a telegraphic transfer fee – the cost of wiring the money to the solicitor. This is usually only around £35, but some lenders might charge less.
The next important fee to look at is the early repayment charge (ERC). This is deal-specific but tends to be around 3% of the amount borrowed. You will have to pay this fee if you redeem your mortgage fully within the rate period - so, 24 months if you have a two-year fixed rate. Most lenders allow some facility for you to overpay on your mortgage, but if you exceed this amount then you will also have to pay the ERC.
“Make sure you know how much you can overpay and what the ERC is,” says Hollingworth. “You can find out from your lender or from your mortgage paperwork.”
While the ERC might not be relevant when comparing the true cost of a mortgage, it can be the tipping point if you find two deals that are very similar.
Finally, you should also make sure you understand what the fee is when you close the mortgage – this is known as an exit fee and covers the lender’s administration costs. This varies but is usually a couple of hundred pounds.
Other expenses that you might face as a borrower are what Hollingworth terms “dark charges”. These are fees if you miss a repayment and fall into arrears. However, Hollingworth adds: “If you think you might face paying these before taking out a mortgage, I would urge you to think again about borrowing at all.”
There is no ‘magic way’ to work out the impact of the fee of the total cost of your mortgage, as it will depend on the amount you need to borrow.
However, the easiest way to judge the impact of fees on your mortgage costs is to look at the total cost of all fees over the period you intend to stay on a particular deal. So, if you are opting for a two-year fixed rate you need to take all the costs into consideration, including fees and repayments, for 24 months. If your loan is for an initial rate period of five years, you need to look at the total cost over 60 months.
If you buy a mortgage through a broker they will work out the true cost on your behalf. And when it comes to comparing deals yourself online then make sure you use a comparison tools that allows you to take these fees into account and calculates the true cost of your behalf.
Moneywise’s Get help finding the best mortgage for youis free to use and allows you to search for mortgages based on the true cost, as well as the headline rate.
You can also streamline your results based on the type of mortgage you want (fixed or variable, for example), the payment option (interest-only or capital repayment), and your specific circumstance - including whether you are self-employed or want a shared ownership deal.
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
“Arrears” tend to be associated with debt. If you fall behind and miss payments on any outstanding debt, the amount you failed to pay is an arrear – the amount accrued from the date on which the first missed payment was due.
A charge some brokers (and, increasingly, lenders) make for arranging your loan or mortgage, either as a flat fee or a percentage of the amount you wish to borrow. In order to look ultra-competitive in the best-buy tables, some mortgage lenders will offer mortgages with an attractive low rate and recoup any losses with a hefty arrangement fee.
Not to be confused with an early repayment charge (ERC). Exit fees are levied on top of ERCs, which are a method of clawing back lost interest on a loan repaid early. By contrast, exit fees are charged for the administrative work this entails. They are charged as flat fees, from £150 to £300. However, in January 2007, following mortgage lenders surreptitiously raising fees sometimes by fivefold, the Financial Services Authority (FSA) intervened and most mortgage lenders removed exit fees from new mortgages. If you paid exit fees on your mortgage before January 2007, you may be able to claim them back.