Mortgage arrangement fees are an increasingly important source of income to lenders. And the fees - which can be over £2,000 for a fixed-rate mortgage - make a real impact on the total cost of a mortgage to a home buyer.
Mortgage lenders are offering buyers a trade-off between a higher initial fee and a lower rate of interest, or a mortgage with a low fee or no fee and higher interest charges. Charging a significant upfront fee allows lenders to reduce their interest rates, and so appear in mortgage best-buy tables, but still make a profit.
Higher fees can, though, work in the buyer's favour. This is especially the case for borrowers with larger mortgages, as the fee will be more than offset by the savings on the interest rate. But there are several important caveats: the amount of the fee, whether it is fixed or a percentage of the mortgage sum, and the length of the low interest rate.
Is there a "break even" point where it makes sense to pay a fee?
If a mortgage arrangement fee is a fixed sum - whether that is £500 or £2,000 - it is relatively easy to calculate whether it makes sense to pay it, by working out the interest rate savings.
But even mortgage experts struggle with the sheer range of fees and deals on the market. The up-front fee is only part of the picture: most lenders now also charge exit fees (ranging from around £90 to over £200) and home buyers might also have to pay for a valuation and for legal work.
The financial website Moneysupermarket.com has studied the impact of fees on the total cost of a mortgage, and concluded that home buyers with loans over £57,000 are generally better off paying a fee. But that is not the same as saying that buyers should pay any fee, Louise Cuming, Moneysupermarket's head of marketing, cautions.
Moneysupermarket estimates that for most borrowers, a fee of £500 to £700 can make sense. For the larger sums that many home buyers now have to borrow, however, fees can make sense.
For a mortgage of £150,000, Nationwide's 4.47 per cent, two-year fixed-rate costs £15,008 including a £1,598 fee. Alliance and Leicester, at 4.74 per cent with a £799 fee, costs £15,019. Portman, with no fee and a 5.49 per cent rate, costs £16,470, again for two years.
Is it a good idea to add the fee to the loan?
Many home buyers may have no choice but to add fees to the loan. But doing so is expensive, as the lender will charge interest on the fee for 25 years. If the fee is large, it is even possible that it will not have been repaid at the fixed-rate period.
One option is to add the fee to the mortgage, and then use overpayments - assuming these are allowed under the mortgage deal - to pay the fee back as cash flow allows. Another, suggests Ray Boulger, senior technical manager at brokers John Charcol, is to reduce the mortgage term. If a home buyer pays a fee in return for a lower interest rate, their monthly payments will be lower.
This means they could pick a shorter term mortgage and still stay within their monthly budget. But the total amount of mortgage interest paid would be lower.However, home owners need to be ready to switch to a new mortgage deal after their fixed or discounted rate ends, warns Cuming. Even a few months paying a lender's standard variable-rate mortgage will wipe out any savings from the discount.
How long will it take to pay back arrangement fees?
With a standard repayment mortgage, the homeowner's monthly payment to the bank or building society includes both interest and capital. Each month the proportion of interest reduces and the amount of capital repaid goes up, so monthly payments stay the same and the loan is repaid after 25 years. The exact amount of capital (debt) paid off each month depends on both the interest rate and the mortgage term.
Assuming an interest rate of 5 per cent and a 25-year mortgage, a homeowner will pay back around 10 per cent of their mortgage in five years, and 3.5 per cent in two years. On a mortgage of £15,000 that comes to £5,250.
As a result, anyone who adds fees - including valuations, legal charges, stamp duty and arrangement fees - of more than 3.5 per cent to their mortgage would find that, after two years, they had repaid none of the property's purchase price. The repayment element of their mortgage would simply be paying off the fees.