The sting in a mortgage tale

While borrowers fixate on getting the very lowest interest rates on their mortgages, they may fail to notice the quiet yet dramatic rise in arrangement fees.

Mortgage arrangement fees, also known as booking or completion fees, are payable to the lender when you secure a mortgage. Until recently they have been £200-£400, but lower level fees have become increasingly rare and very high fees have been creeping into the market.

For example, a current Birmingham Midshires mortgage carries a significantly high arrangement fee of £1,500, but has an extremely low interest rate at 0.76 per cent less than Bank of England base rate and does not include any penalties to tie borrowers to the mortgage once the two-year offer expires.

In addition, Northern Rock is currently offering a buy-to-let mortgage carrying an arrangement fee of a considerable £895, but attracting customers with a solid 6.69 per cent fixed rate for seven years.

Rob Clifford, of independent mortgage adviser Mortgageforce, says: 'There is a definite move towards higher fees. Lenders are designing more of their mortgages to have very high upfront fees and low interest rates. Our concern about this is that some consumers do not look all that closely at fees and penalties that have an impact on the overall cost of mortgages.'

Clifford also says borrowers' decisions can be clouded further by offers from lenders to split larger arrangement fees so that customers pay a modest upfront fee with the rest added on to their mortgage, lessening the blow of a large cost. Adding the cost of fees to your mortgage can make poor financial sense: paying £400, for example, over a term of up to 25 years will see the interest paid on this relatively small amount build up. Where possible, borrowers ought to try to pay any fees upfront, no matter how big or small.

To those wrestling with whether a high arrangement fee is worth shouldering for the sake of a low-interest rate, Mark Harris of mortgage adviser Savills Private Finance says: 'The bigger the fee, the more important it will be to calculate whether it's worth paying. As a general rule, the bigger the mortgage, the more likely it is going to be worth paying a high fee for a very low rate. If your mortgage is for anything less than £200,000 then I would be particularly cautious about paying a large arrangement fee.'

Birmingham Midshires says its mortgage with the £1,500 arrangement fee effectively lends money at less than the cost of the funds. It also makes the point that the product is only available through intermediaries who typically deal with high net worth clients, reflecting its suitability to customers with larger loans, as well as the need for advice.

Most of Northern Rock's residential mortgages carry arrangement fees on the high side at £595 to £695. It says it offers customers a choice of whether to accept fees or alternative changes to their mortgage packages.

Brokers claim rising fees are a result of lenders looking for ways to recoup the cost of implementing a new mortgage regulation framework, which comes into force from the end of this month. Remarkably, the mortgage market had never been fully regulated and lenders have been forced to spend millions getting their systems, literature and staff fully compliant with the Financial Service Authority's rules. Lenders say there is not a direct link between rising fees and the cost of regulation, but nevertheless brokers are urging customers to remain vigilant as fees and redemption penalties appear to be creeping up.

Redemption penalties are the exit charges levied if you switch mortgages during a set period, usually an initial offer period, and sometimes after it has expired. The penalties are usually a percentage of the amount of interest accrued over a period of time, or a percentage of your outstanding mortgage balance. Most lenders charge 1 to 3 per cent, though mortgage brokers say these charges are also being inflated.

One current mortgage from Northern Rock charges penalties at 5 per cent in the first year, but this rises to a punishing 9 per cent in the second and 8 per cent in the third. Penalties linger until seven years after the mortgage was taken out. This mortgage does, however, offer a very attractive initial fixed rate of 2.79 per cent until November 2006. Northern Rock argues this product is not a large part of its business and might be most suitable for individuals who cannot afford high repayments at the outset, but who may have rapidly increasing salaries and would therefore be able to cope with higher repayments in years to come.

Those looking for the combination of a competitive interest rate, plus reasonable penalties and arrangement fees, might consider West Bromwich Building Society's two-year fixed deal at 5.29 per cent, with a £395 arrangement fee and no redemption penalties after the initial offer period is up.

Contacts:

Mortgageforce www.mortgageforce.co.uk, 01332 258666

Savills Private Finance www.spf.co.uk, 0870 900 7762

Northern Rock www.northernrock.co.uk, 0845 601 1581

Birmingham Midshires