Fee-free mortgages can cost you more!

a model of a houseFancy bagging a low rate mortgage without forking out for a hefty arrangement fee?

Average mortgage fees topped £1,500 earlier this year (according to Moneyfacts), so when Barclays launched a best buy, fee-free fixed rate, it no doubt caught the attention of many a cash-strapped homebuyer.
But borrower beware, because while the Barclays deal really is market-leading, not all fee-free mortgages will work out cheaper than deals that carry an upfront price-tag.

Andrew Montlake, director at mortgage broker, Coreco, says: "Fee-free mortgage deals can really help out hard-pressed homebuyers at a time when they have so many other expenses to consider. But you could end up paying a premium on your interest rate in order to avoid paying a fee upfront."

Best of both worlds
The Barclays fee-free mortgage is a two-year fixed rate at 3.29% and it's available up to 70% of the property's value, meaning you will need at least a 30% deposit to access it.

When you compare this deal to other two-year fixes available to borrowers with the same amount upfront it stacks up well, even against deals that charge arrangement fees of £1,000 for example. So it's a great all-rounder.

The big drawback of the Barclays fee-free deal is that it's only available to those buying a home, so you can't access it if you simply want to remortgage.

Also, the deal can be pipped on rate alone. Nationwide offers a two-year fixed rate for those with a 30% deposit at a slightly lower 3.19%, but with a fee of £999, so for many borrowers the Barclays deal would work out cheaper over the two-year fixed period.

For those who can muster a larger deposit of 40%, there are some significantly lower interest rates on offer – with HSBC offering a two-year fix at 2.64% for example.

However, what the Barclays deal does well is combine a fee-free mortgage with an almost market-leading rate.

What borrowers need to remember is that this isn't the norm.

Take your pick
The way that that mortgages usually work is that the cheapest rates tend to come with higher than average arrangement fees.

And as a rule of thumb, when lenders offer a fee-free deal, they add a bit onto the interest rate to account for it.

Of course there are exceptions, but that's how it often works. Mortgages are designed using different pricing mechanisms and a lender will alter the balance of these to achieve a particular return on the money it lends.

It's up to you to decide which of the many rate and fee combinations available suits your needs best. For example, if you have decent earnings but a small savings pot, you may prefer a fee-free mortgage to minimise your upfront costs, even if it means you pay higher monthly repayments.

Likewise if you have inherited a large sum but you earn a modest salary, it may suit you better to pay a high upfront fee if that means you can access a low interest rate, and lower ongoing costs.

Most of us sit somewhere in the middle, and it can be hard to compare deals when they come with such different fees. One smart way is to calculate the total cost of a deal over a set period.

Overall cost
If you take out a two-year fixed rate mortgage, for example, it makes sense to compare the total cost over that period, including both the interest rate and the arrangement fee.

This can really help when you are considering deals that have very different fees attached, or no fees at all.

Simply multiply the monthly repayments by the number of months – so 24 for a 2-year fixed rate – and then add on the mortgage fee.

These true cost calculations can throw up some interesting findings, proving that sometimes a fee-free deal won't save you money overall.

For example, say you need to borrow £150,000 and are comparing two deals – one with a high fee and low interest rate, and one fee-free deal with a higher rate of interest.

HSBC offers two five-year fixed rates for borrowers with a 10% deposit. One is fee-free with a rate of 5.39% and the other comes with a £999 fee and a rate of 4.79%.

Over five years the fee-free deal will cost £54,660, but the deal with the fee of £999 is significantly cheaper on a true cost calculation at £52,539 – including the fee – because the monthly savings from the lower interest rate really add up over the five years.

Size matters
There is another variable to consider which can have a big impact on whether or not a fee-free deal suits you. As a rule of thumb the more you borrow the more important it is to find a lower rate of interest, even if you have to pay a large fee to bag the deal.

If you are borrowing a smaller sum, a large fee will make up a larger proportion of your total cost and therefore it is worth looking at deals with no fees, even if that means the interest rate is a bit higher.

As always, the best deal for you depends on your circumstances, your current financial position and your level of borrowing. That could well be a fee-free mortgage, but remember to work out the whole cost of a deal, not just the upfront expenses.

Montlake agrees: "By working out the total cost of a mortgage over a set period you can compare deals more easily. If you want help a good mortgage broker will do all the sums for you, and tell you exactly which mortgage best meets your individual needs."

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