Avoid this massive fixed mortgage deal mistake

These mortgage deals are really cheap right now, but take one out and you'll regret it, says Jane Baker.

If you have a big deposit - or a large amount of equity in your home - you could say the economic crisis has had some positive effects. For one thing, rates on the most competitive mortgage deals have dropped significantly.

Some still argue mortgage pricing is much higher than it should be given the actual cost of lending for banks and building societies. But the fact remains, if you meet the criteria for the best deals, you could bag yourself a very cheap rate.

But what's cheap today, may not be cheap tomorrow....

Short-term fixes

If you're a fan of fixed-rate mortgages, you may have noticed how low rates have dropped, particularly for short-term deals. These days, the most competitive two-year fixed rates are well below 4%.

The following tables illustrate how much lower rates are for short-term fixes (over two years) compared with longer-term deals (over five years). In the final column, I've added the fees and the monthly repayments together, to give you the true cost per year for each deal. 

The products are for remortgagors who have an equity stake of at least 40% in their property. The figures are based on a property price of £200,000 with a mortgage of £120,000, payable over a 25-year term.

Five lowest fixed-rate deals over two years

Source: Moneyfacts. *Total amount payable includes monthly repayments over the two years plus mortgage fees divided by two to calculate the cost per year.

Now let's weigh these deals against the most competitive over five years:

Five lowest fixed-rate deals over five years

Source: Moneyfacts. *Total amount payable includes monthly repayments over the five years plus mortgage fees divided by five to calculate the cost per year.

Short-term versus long-term

On the surface, the two-year deals look considerably cheaper than the five-year deals, both in terms of rate and, more importantly, the true cost per year (which is a more accurate measure of how expensive a mortgage product really is). Clearly, the smaller monthly repayments - as a result of lower rates - have given the two-year fixes the edge. But these tables don't reveal the full story.

There's one piece of the jigsaw missing: remortgaging costs. It's a fairly obvious point that short-term deals will mean more remortgaging if you want to keep your mortgage competitive. But borrowers often overlook the extra cost this entails.

How much will remortgaging set me back?

Unless your lender's standard variable rate (SVR) happens to be attractive - which is becoming increasingly unlikely, given that SVRs are beginning to climb - or you can find a competitive fee-free deal, remortgaging will almost certainly mean paying product fees all over again.

Think about this way: during a five-year period a borrower who always fixes their rate for two years will have to remortgage twice and will pay product fees on three separate occasions - once at the beginning of the period, then again after two years and four years. But a borrower who fixes for five years will only have to pay a product fee once at the start of the term.

So, how much extra might remortgaging twice cost the first borrower?

It's difficult to say with any great accuracy but here are some rough figures. Let's say product fees remain at roughly the same level in two and four years' time as they are now. According to lovemoney.com partner, Moneyfacts, average product fees cost around £918 today. That means an extra £1,836 needs to be taken into account for the borrower who repeatedly chooses two-year fixes over a five-year period.

Based on the same true cost calculation, that would add another £367.20 in fees each year (£1,836 divided by 5). If you include this amount in the top Alliance & Leicester two-year fixed deal it actually becomes more expensive by true cost - at £8,633.72 - than some the lowest rate five-year deal in spite of that ultra low 3.15% rate.

On top of this you may also need to pay a mortgage exit administration fee when you leave your original lender. This cost is supposed to cover the legal and admin costs the lender incurs for changing the registration of the property at the Land Registry. And you may also have to pay a valuation fee each time you remortgage too. These additional costs could easily add an extra few hundred pounds to your total cost and shouldn't be overlooked.

What will happen to mortgage rates?

It's true the rest of the two-year fixes shown in the table still beat the five-year deals on true cost even with the additional remortgaging fees. But, of course, all this assumes that mortgage interest rates remain the same. Don't forget, each time you switch deals, the new fixed rate you pay could feasibly be higher than the rate you're paying now. Who's to say where rates will be in two or four year's time? Experts are already predicting rises will take place this year. Remember, rates are at a record low at the moment - they will only get higher in the future.

If you're unable to remortgage to a better or equivalent rate when the time comes, the higher monthly repayments will push the true cost even higher. So I suggest you proceed with caution if you're tempted by the promise of cheaper repayments with a super low rate on a current short-term fix.

Personally, I would go for the relative safety of a five-year fix which not only guarantees repayments for a longer period, but isn't as expensive as you might think compared with these shorter deals.

If you're still not sure what to do, why not ask other lovemoney.com homeowners for their opinions using our Q&A tool? And once you've got your new mortgage up and running, make sure you join our Cut your mortgage costs and pay off your mortgage early goal to help you become mortgage-free as soon as you can.

If you're looking for a new mortgage or remortgage, speak to an independent broker using the lovemoney.com mortgage service.

More: The benefits of using a mortgage broker | Property hotspots of 2009!