The 2.6% mortgage trick

Get suckered in by a super low mortgage rate and it could cost you thousands.

Right now, the best-buy mortgage rates look really attractive. The top two trackers are a snip at under 2%, while fixed rates of less than 3% are becoming increasingly common.

But when the time comes to choose a new mortgage, you should always remember one thing: It’s never just about the headline rate. That’s the rate you’ll see plastered all over the adverts. But if you want to judge whether a mortgage deal really is good value, there's a lot more to it than that.

What is the true cost of the mortgage?

Instead of looking at the initial interest rate alone, you should also calculate the ‘true cost’ of any mortgage deal before you sign up. So what's true cost? Quite simply, this figure equates to the total amount repayable for the deal in question including the following:

• The monthly repayments;
• The fees for arranging the loan - often known as a product fee or booking fee;
• The valuation fee;
• An estimate for legal costs;
• Any other extra costs
• Any cashback offered can be deducted from the true cost figures, as can free valuations and/or legal fees.

The tables below demonstrate the huge difference between the ‘best-buys’ depending on whether they're based on the headline rate only, or take the true cost into account.

Note that the true cost calculations are based on a £120,000 mortgage payable over a 25-year term. The first table shows the top two year-fixes by rate, followed by the same selection ordered according to the true cost:

Top two-year fixes by rate

Source: Moneyfacts. *Available from selected mortgage intermediaries only

These great rates are undoubtedly eye-catching. The Alliance & Leicester two-year fixed rate at 2.64% looks cheaper than the rest, and very tempting. But you’ll see from the true cost column, that it’s by no means the most competitive deal overall, costing £1,880 more in this instance than, for example, the ING Direct deal at 2.84%.

This is primarily down to an excessively high product fee. In Alliance & Leicester’s case this runs to a massive 2% of the mortgage advance (that is the amount you borrow). Given that the mortgage loan in this example is £120,000, the product fee is a whopping £2,400. This bumps up the true cost above all but one of the other deals in the table. So, even though A&L offers the lowest two-year fixed rate, it certainly isn’t the most competitive.

Of course, this may not always be the case. The benefit of this type of product fee is that the smaller the mortgage, the smaller the fee. And vice versa. So don't assume that mortgages with product percentage fees are always bad, especially if your mortgage is very small. You need to figure out the true cost before you can make an informed decision. (See working out your true cost calcuations, below, or ask one of our award-winning brokers to do this for you, for free.)

But whatever you do, make sure you don't get suckered into thinking that because the headline rate is low, the mortgage is cheap.

Now, let’s take a look at the deals which really are good value in terms of true cost:

Top two-year fixes by true cost

Source: Moneyfacts.

This time the selection is completely different with HSBC topping the table. The rate is higher than any of the deals shown in the table above, but the true cost over two years is just £13,921 - this is considerably cheaper than Alliance & Leicester. In fact, you would save yourself a hefty £2,323 by choosing HSBC instead which charges a tiny product fee of £99.

It’s a similar story with trackers too. The next two tables show the top deals by rate and then by true cost:

Top two-year trackers by rate

Source: Moneyfacts. *Available from selected mortgage intermediaries only

Here Cheltenham & Gloucester/Lloyds TSB Scotland offers the cheapest two-year tracker rate of just 1.99% (bank base rate + 1.49%). But again it’s the extortionate product fees which let the deal down in the end. The lenders charge a staggering 2.5% of the mortgage advance which runs to £3,000 based on this £120,000 mortgage loan. And, as if that wasn’t bad enough, a miscellaneous extra booking fee of £99 is added on. Talk about adding insult to injury!

Not surprisingly, this renders the Cheltenham & Gloucester/Lloyds TSB Scotland uncompetitive compared with the next selection:

Top two-year trackers by true cost

Source: Moneyfacts. *Available from selected mortgage intermediaries only

The deal which offers the best value for money from NatWest/RBS costs £13,474 over two years (of course this figure would change if the tracker rate moved). This is £1,818 cheaper than the lowest rate deal from C&G/Lloyds above. So you can see with all types of mortgage deals it really pays to choose on the basis of true cost, rather than being duped by a low rate.

Working out your own true cost calculations

Calculating true cost yourself is actually pretty easy. The first step is to work out how much your monthly repayments would be for each deal you like the look of. Simply use this mortgage calculator to help you. Then follow these four steps:

1. Multiply the monthly payments by the number of months the deal lasts for. So, if you’re looking at deals over a two-year period, multiply the monthly payments by 24.

2. Next add on the fees including the product fee, valuation fee and legal costs.

3. Deduct any cashback you’re entitled to as part of the deal. If any of the fees are rebated or free, remember to subtract them from your total.

4. This will give you a true cost figure for the length of the deal. If you want to calculate the true cost per year, simply divide the total by the number of years the deal lasts for. In this case divide the total by two.

You should now have the true cost including the repayments and all applicable fees. This calculation will give you everything you need to help you decide whether a mortgage deal really is as good as it seems.

Finally, if you don't fancy crunching the numbers yourself, don't forget the lovemoney.com mortgage brokers? are here to help.

More: Fix your mortgage rate under 4% for five years | Beware of this rip-off mortgage cost

At lovemoney.com, you can research all the best deals yourself using our online mortgage service, or speak directly to a whole-of-market, fee-free lovemoney.com broker. Call 0800 804 4045 or email mortgages@lovemoney.com for more help.

This article aims to give information, not advice. Always do your own research and/or seek out advice from an FSA-regulated broker (such as one of our brokers here at lovemoney.com), before acting on anything contained in this article. 

Finally, we tend to only give the initial rate of a deal in our articles, but any deal which lasts for a shorter period than your mortgage term may revert to the lender's standard variable rate or a tracker rate when the deal ends. Before you take out a deal, you should always try to find out from your lender what its standard variable rate is and how it will be determined in the future. Make sure you take all this information into account when comparing different deals.

Your home or property may be repossessed if you do not keep up repayments on your mortgage.