When the gift of a cheap home loan is unravelled by rising arrangement fees

But is it still worth paying upfront in exchange for a lower rate? Laura Brady talks to advisers and homeowners

The festive decorations beginning to adorn our shops and streets tell us that Christmas, traditionally a time for giving, will shortly be upon us.

The festive decorations beginning to adorn our shops and streets tell us that Christmas, traditionally a time for giving, will shortly be upon us.

But don't expect this to make a difference to the increasing number of mortgage lenders that are giving with one hand and taking back with the other.

Lender arrangement fees - also levied under the guise of completion, booking or administration fees - have grown from a typical £195 to £295 over the past 12 months, according to mortgage broker Charcol. This represents a rise of more than 50 per cent.

Fees as high as £695 are no longer uncommon and, in isolated incidences, have hit as much as £1,500.

For your money, you can expect a cheaper interest rate on the mortgage - but it won't always be in your interest to go for the product.

"The highest fees are usually linked to deals with attractive low interest rates," says Rob Clifford, managing director of the broker MortgageForce.

Such deals are currently easy to sell, especially to a nation of homeowners knocked back by the five Bank of England base rate rises, to 4.75 per cent, since last October.

One of the best examples of low rates and high fees is a product offered by Birmingham Midshires building society. It is currently offering a two-year tracker mortgage set at 0.76 per cent below base rate. This gives a highly attractive pay rate of 3.99 per cent but there is a catch: a whopping £1,500 arrangement fee.

Elsewhere, Northern Rock offers a two-year flexible deal fixed at 4.69 per cent which comes with a hefty £695 arrangement fee - as do all its residential mortgages. The lender does offer a fee-free version, but the rate is then bumped up to 5.04 per cent.

One explanation for the increased fees is that rising administration costs have a tendency to slip through the net when the home loan "best buy" tables that appear in the media are being compiled.

"When it's only the low headline rate that is considered [in the tables], and other factors such as high arrangement fees and whether interest is calculated on a daily or annual basis are ignored, it can become completely misleading," says Ray Boulger, technical director of Charcol.

"Lenders are going to concentrate on producing lower rates and perhaps charge higher fees to compensate."

For their part, many lenders blame the fees hike on the cost of the tighter mortgage regulation that came into effect at the start of this month. (Sales of domestic home loans are now overseen by City regulator the Financial Services Authority.)

This extra administration cost to the industry of complying with this new regime is estimated to be up to £100 per loan, according to the Council of Mortgage Lenders. But lenders' piecemeal approach to passing on this cost, by imposing higher charges, has come in for criticism. "Although the borrower will ultimately foot the bill for regulation, it begs the question of why these fee rises have been inconsistent - not only between lenders but between products offered by the same lender," says Mr Clifford.

But are the higher fees worth paying, even so? "It's often a trade-off," explains Melanie Bien, spokeswoman for broker Savills Private Finance. "If your mortgage is considerable, say £150,000 or more, it makes sense to pay a sizeable fee in order to pay less interest each month.

"But if you have a small loan, a slightly higher interest rate and a smaller upfront fee make more sense."

Remortgagers with small loans outstanding should look at fee-free deals offered by the likes of Yorkshire building society and HSBC.

Borrowers seeking to trade a higher fee for a lower interest rate should also ensure that the deal comes without extended tie-ins, adds Mr Clifford.

Watch out too, he says, if you're thinking of adding the fee to your existing loan rather than paying it upfront: this can mean paying several times over.

For example, stick a £695 fee on to your 25-year deal and you'll have to pay interest on a comparatively small sum over a long period. So it makes sense to clear any fee at the time you take out the mortgage, if you can, to keep costs to a minimum.

Two months ago, Gabrielle Sharp and her husband John upped their mortgage by £100,000 to £260,000 when they moved into a brand new three-bedroom semi-detached house in Southampton.

"We had previously been paying 6.79 per cent, the standard variable rate with the Woolwich, but couldn't have afforded to continue on that with anything larger," says Mrs Sharp, 35, who works as a manager for the Citizens Advice Bureau.

With this in mind, the couple's priority was to secure the lowest interest rate on the market - even if it did mean paying expensive fees.

"We were recommended a two-year tracker from Birmingham Midshires set at 0.51 per cent below base rate," says Mrs Sharp. "This means we are currently paying just 4.24 per cent - and if rates go down as expected, this will get even better."

In return for the low rate, the Sharps were charged a £699 arrangement fee, which they decided to add to their loan.

"It is a lot," adds Mrs Sharp, "but we got what we needed in return. We're only tied in for the length of the deal, so we'll shop around again when it runs out."

WHEN DOES IT MAKE SENSE TO PAY HIGHER CHARGES?

Lender: Northern Rock

Rate: 4.69 per cent (fixed until 1 January 2007)

Arrangement fee: £695

Minimum deposit: 25 per cent

Initial rate per £1,000 of mortgage: £5.74

Lender: Alliance & Leicester

Rate: 4.79 per cent (fixed until 31 January 2007)

Arrangement fee: £395

Minimum deposit: 5 per cent

Initial rate per £1,000 of mortgage: £5.80

On a 25-year, £150,000 repayment mortgage, paying Northern Rock's higher fee works out cheaper in the long term. But the deposit will deter many borrowers from applying. Source: Savills Private Finance

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