The rising cost of mortgage rates has hardly been out of the headlines in recent months but a more punishing measure of inflation for homebuyers and remortgagers has largely escaped the consumer radar: mortgage arrangement fees.
Initial charges on two-year fixed-rate deals were hiked a couple of years ago – rising from an average £514 in June 2006 to £968 last month. Now variable-rate mortgages are getting the same treatment. According to figures from the financial data provider Moneyfacts, the average arrangement fee for this type of loan has reached £1,023, compared with £823 just six months ago. This escalation comes as the credit crunch has left banks short of cash and looking to squeeze as much profit out of borrowers as possible.
Darren Cook, head of mortgages at Moneyfacts, explains: "Arrangement fees on fixed-rate deals started to rise rapidly some time ago when the market was so competitive that lenders producing the cheapest rates had to make up the difference in high fees. But now that interest rates on fixed rates are rising [the average two-year deal is today priced at 7.05 per cent], borrowers are rushing back to variable rates, so lenders are whacking charges on those instead to try to boost their financial reserves."
This means that even standard variable rate (SVR) deals – which traditionally came with no fees or tie-ins, in return for the borrower being exposed to the prospect of rising payments – have now been loaded with arrangement fees. For example, last week, Derbyshire building society introduced a £499 fee on SVR lending (7.09 per cent) for new borrowers, while Clydesdale Bank charges them £599 on its 7.14 per cent SVR.
For most borrowers, however, fees and interest rates should be viewed as nothing more than a case of swings and roundabouts, says Andrew Montlake, partner at the broker Cobalt Capital. "Actually, most lenders offer a range of options, meaning borrowers can choose between a lower interest rate and higher fee or higher rate and lower fee. After all, an arrangement fee is just part of the cost of the deal. It doesn't matter to lenders what way round it is; they just need to achieve a given profit margin."
For example, at Nationwide building society, borrowers can choose between a 5.98 per cent two-year tracker deal with a standard £599 fee, and a cheaper 5.78 per cent version that comes with a fee of £1,499. Zoe Stevens, spokeswoman at the lender, says: "As homeowners come off cheaper deals during the year, many prefer the option of keeping down monthly repayments while paying a fee."
A more extreme example of this trade-off arrived last week from broker John Charcol in the form of a two-year tracker mortgage for loans between £500,000 and £5m. The cheapest deal is priced at Bank of England base rate minus 0.01 per cent, which gives a current pay rate of 4.99 per cent. But this comes with a 2.75 per cent arrangement fee, which means that on the maximum £5m loan a borrower would pay £137,500 – a sum that could buy an entire property in some parts of the country. Borrowers can opt for a lower fee of 1.25 per cent but only if they take on the more expensive interest rate priced at 0.74 per cent above base (currently payable at 5.74 per cent). In addition, both deals require a minimum deposit of 35 per cent.
"Generally, bigger fees are worth paying on larger loans as a competitive rate of interest becomes more important the bigger the debt," says Mr Boulger. "The typical threshold under which you should avoid fees is around £150,000. But lenders have clocked this calculation too and now often impose a lending cap on their lowest-priced deals of a typical £250,000."
The length of the mortgage term is also important; quite simply a £1,000 arrangement fee will cost £500 a year on a two-year deal and £200 a year on a five-year deal. This can be be expensive for those borrowing a relatively small sum over a short period, warns Mr Cook at Moneyfacts: "For example, on a two-year fixed rate of £150,000, every £100 you add to the loan [in the form of an arrangement fee] over that time equates to an additional 0.6 per cent on the interest rate."
The complexities in the way loans are structured makes it difficult for borrowers to shop around and compare "best buy" deals, says Mr Montlake. "Consumers are no longer comparing apples with apples; they are comparing apples with oranges."
At least some variable-rate deals remain straightforward. While short-term tracker mortgages have always incorporated fees, open-ended deals can still be picked up free of charge. The Woolwich's lifetime tracker mortgage, for example, is entirely fee-free and comes with no early repayment charge. For borrowers with a 40 per cent deposit or more, the rate has just been reduced to 0.89 per cent over the Bank of England base rate (currently equivalent to 5.89 per cent), although those with a 20 per cent or 10 per cent deposit will pay 1.39 per cent and 1.59 per cent over base respectively.
It's also unlikely that the fees on variable-rate mortgages will rise much further, according to Mr Cook, who says: "There still needs to be a logical incentive to take the risk of a variable rate." However, he adds: "It will take the market another six months to settle down."