Pay nothing for your mortgage rate

Fee-free deals on mortgage rates look very attractive if things are a little tight, but are they as good as they seem?

The costs of buying a property are substantial, and boy do they stack up quickly.

So forking out for a mortgage arrangement fee on top of your deposit, Stamp Duty and other costs can be a right royal pain -- and a significant sum to find if money is tight.

It’s worth knowing they are also sometimes called booking fees, completion fees or application fees, and some lenders split the cost between two fees, but you have to pay both -- Nationwide charges a ‘booking’ and ‘reservation’ fee for example, so remember to add them up.

Rising costs

It doesn’t help that average mortgage arrangement fees have shot up in recent years. They were £411 in November 2005 and peaked at £1,211 at the start of 2009, before dropping back slightly to their current level of £918, according to financial information provider Moneyfacts.

So you don’t get much change from a grand.

You can pay your arrangement fee upfront if you have the money, or add it to the mortgage, in which case you will be paying interest on the sum for a long time, and it will end up costing you more overall.

But there is another option -- you could pay absolutely nothing upfront by getting a fee-free mortgage.

Fancy a no-fee deal?

In the last few months there has been a noticeable rise in the number of fee-free mortgages coming to market. In December 2009 there were 139 fee-free deals compared to 174 now, according to Moneyfacts -- a 25% rise.

These are mortgages that come with no arrangement fee whatsoever and, in a few cases, lenders are even offering fee-free deals that also come with no valuation and legal fees -- literally no upfront costs to arrange your mortgage at all.

Brilliant, where do we sign up?

Robbing Peter to pay Paul?

However, it’s not quite as simple as that, as fee-free deals are not always the best, or cheapest option. Lenders need to make a certain margin on their mortgages and they do it through two price mechanisms -- the interest rate they charge and the arrangement fee.  This is why you see high fees on some of the lowest rate deals -- the lenders have to get back their money somehow.

The same can be said for fee-free deals in theory, since lenders are effectively losing out on £1000 in fees. Because of this they often charge expensive interest rates to claw that money back.

Indeed, as you would expect, average fee-free deals do have higher interest rates than average deals with fees.

Moneyfacts says that average fee-free fixed rates are currently 5.58% compared to average fee-charging fixed rates which are 5.09%.

This is quite a big difference, 0.49%, which represents about £1,500 in interest payments over a two-year deal (based on a £150,000 mortgage) --  more than enough to cover that arrangement fee!

What is even more interesting is that the difference in interest rates between fee-free and fee-charging fixed rates has doubled in the last month from 0.25% to 0.49%. In fact the price differential was a tiny 0.6% in September 2009, so it has massively widened in the last six months.

In defence of fee-free deals

Despite this, I like fee-free mortgages, and I think it’s completely fair that they come with more expensive interest rates.

Firstly, they suit certain borrowers who are willing to pay a higher rate of interest for the benefit of no upfront fee.

Say you have a decent salary and can easily afford to service a mortgage for example, but your immediate cashflow is tight or, for whatever reason, you HAVE to put all your available savings towards the deposit or something else.

It might be more practical for you to get a fee-free mortgage and save on upfront costs, even if you have to sacrifice a bit on the interest rate side to do that. Perhaps it’s not financially the best option over the long term, but real life doesn’t always work like that.

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Perfect for small loans

Fee-free deals can also work in the favour of those with small mortgages, where the interest rate doesn’t have as big an impact as it does on jumbo loans. Here’s an example:

Northern Rock currently has a two-year, fee-free fixed rate at 3.99% up to 70% LTV. Its equivalent fee-charging deal is quite a bit cheaper at 3.59% and comes with a £995 fee.

For someone with a modest £100,000 repayment mortgage the fee-free deal would cost £527.28 a month, totalling £12,655 over the two-year fixed period.

If they went for the cheaper deal their monthly repayments would drop to £505.46, totalling £12,131 over the two years. But add on the £995 arrangement fee and the total cost is actually £471 more expensive than the higher rate deal, coming to £13,126.

So, fee-free deals with higher rates can be cheaper for some borrowers.

Finally, there are actually some best buy fee-free mortgages that are so stonking they are better than many of the fee-charging deals on rate alone.

Yorkshire Building Society has a two-year fixed rate available up to 85% LTV with no fee and £500 cashback priced at 5.39%. This rate is a best buy, before you even take into account the fact it is fee-free and comes with cashback.

NatWest’s two-year tracker at 4.69% up to 90% is another example of a fee-free mortgage that competes on rate alone.

Below are some of my favourite fee-free deals, split into fixed and variable rates:

12 fixed fee-free belters

8 terrific fee-free variable deals

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