Don't Fall For This Sneaky Trick!
The lowest mortgage rate isn't always the best.
Mortgages are far less competitive now than they were a year ago, but if you are coming up for renewal, you will still want to get the best available deal to minimise any increases in your monthly repayments.
Consider what will happen if you do nothing. You will probably revert to your lender's standard variable rate (SVR), which will usually mean a jump in repayments - ask your lender to work out the exact difference.
Then look around the market for deals you could switch to. Here at The Fool, we've just launched a nifty little calculator that you can use to check whether you'd be better off staying on the SVR or switching to a new deal. It will work out your monthly repayments on the new deal and show you what you could save - or the amount your payments will increase by.
It will also show you the crucial bit: all the costs involved in switching. This includes the exit fee if you leave your current lender and the arrangement fee with the new deal - plus any other charges.
This means you can work out the overall cost over the deal period. For example if you are going to move to a two-year fixed rate add the costs and fees to two years' worth of mortgage repayments.
The reason fees are so important is that they have risen enormously in the last two years. A fee of £1,200 now comes as standard, and this is the equivalent of £50 a month on top of your repayments over two years.
As a rule of thumb, the larger your mortgage the more important it is to go for a low rate, even if you have to pay a large fee. If your mortgage is modest the fee will impact hugely on your overall cost.
It's vital to do the sums and work out whether the lowest rate means the lowest cost for you.
The examples below illustrate how the lowest rate with an upfront fee is not always the best deal for remortgagors.
Modest mortgage
Assume you have 23 years left to pay on your repayment mortgage and a balance of £100,000. You have been paying a fixed rate for two years of 5.75% and are about to come to the end of the deal. Your monthly repayments are £654.
If you do nothing you'll revert to the lender's SVR of 6.75% and your monthly repayments will rise to £714, a monthly increase of £60 and an extra £1,440 over two years.
So what happens if you look for a cheaper deal?
Say you found a two-year discounted rate mortgage at 6.25% with a fee of £1,000.
Your monthly repayments would be £684- £30 more a month than you are currently paying. But this is still £30 a month cheaper than doing nothing and allowing your current deal to revert to SVR. So, by switching, your mortgage payments will be reduced by £720 over two years.
But, the new deal is less attractive once you take the £1,000 fee into account. It would actually cost you more (£280 more) to move to this lower rate than it would to simply revert to SVR and face no costs.
This doesn't mean you should give up in despair, however. You could still be better off remortgaging, if you go for a significantly higher rate on a fee-free deal, such as a 6.5% rate with no fee. This would result in monthly repayments of £699 - £15 a month cheaper than reverting to SVR.
And there is no fee so you really do save that money. In total, over two years, you would save £360 by remortgaging. In other words the higher rate in this instance works out more attractive.
Summary - Cost of borrowing a £100,000 mortgage over 2 years
Current low fixed rate (5.75%) about to end: £15,696
Revert to SVR (6.75%): £17,136
Low rate, higher fee deal (6.25%): £17,416
Fee-free but higher rate deal (6.5%): £16,776
Best deal: Fee-free, but higher rate.
Massive mortgage
The bigger your mortgage the more important your interest rate becomes and you are more able to swallow a higher fee. Again work out the costs over a specific time period, such as two years.
Assume you have a repayment mortgage of £500,000 with 23 years left to run. Suppose you are currently paying a fixed rate of 5.75% and are about to come to the end of the deal. Your monthly repayments are £3,270.
If you do nothing you'll revert to the lender's SVR of 6.75% and your monthly repayments will rise to £3,572, a monthly increase of £302 and an extra £7,248 over two years.
So what happens if you look for a cheaper deal?
Say you found a two-year discounted rate mortgage at 6.25% with a fee of £1,000.
If you switched to this deal, your monthly repayments would be £3,419 -£149 a month more than you are currently paying, but £153 a month cheaper than reverting to SVR - or around £3,672 cheaper over two years. Taking the £1,000 fee into account, your saving over two years is still £2,672.
What about if you went for a higher rate on a fee-free deal? Let's say you went for a 6.5% rate with no fee. This would result in monthly repayments of £3,495 - £77 a month cheaper than doing nothing. Over two years you would save just £1,848 by remortgaging.
This is a much smaller saving than the other deal, even though you did not have to fork out that huge £1,000 fee.
These sums show that, because your mortgage debt is so much bigger, you would better off going for the low rate, higher fee deal.
Summary - Cost of borrowing a £500,000 mortgage over two years
Current low fixed rate (5.75%) about to end: £78,480
Revert to SVR (6.75%): £85,728
Low rate, high fee deal (6.25%): £83,056
Fee-free but higher rate deal (6.5%): £83,880
Best deal: Low rate, high fee.
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