Why headline mortgage rates aren't important

Ruth Davies 21 October 2015

So far, 2015 has provided some of the most eye-catching mortgage rates a generation of homebuyers has ever seen.

For example, at the time of writing, this HSBC discount mortgage offers an initial rate under one percent:

(To put this in context, in 2008 the cheapest HSBC mortgage you could get was 4.99% variable.)

And in buy-to-let mortgages, you can now borrow at under two percent:

Looking at these deals, it's no surprise that the conversation around mortgage deals is led by initial rate (yes, our mortgage comparison tables use it too). The initial rate determines your initial monthly payment; that's what most borrowers care about, so that's what everyone wants to compare.

But paying too much attention to initial rate alone can mislead you into looking at the wrong mortgages, and missing out on what might be the best deal for you.

Here's why headline rates are, in our view, overrated.

Reason #1: The Fee Factor

Because mortgage customers tend to focus on initial rate, lenders have picked up on this psychology and "hacked" their products to get these rates as low as possible, helping their deals to the top of the best-buy tables.

But this in turn has driven up product fees.

The main product fee (otherwise known as a "application fee" or "completion fee") on a mortgage can nowadays be nearly £2,000 – or even more, if it's a percentage fee based on the purchase price. There might also be a booking fee which is a smaller amount (typically £100) you pay as soon as you reserve the deal. In our comparison tables these are bundled together as "total fees".

So, higher fees usually get you a lower headline rate. But they shift some of the cost of the mortgage deal up front – meaning the lender makes money on the deal more quickly, and you end up with another cash outlay at what is already an expensive time.

You could opt to add fees onto your mortgage loan (most lenders offer this). But if you do, you'll also be charged interest on the fees: so you'll pay substantially more than if you pay them upfront.

How to calculate true cost with fees

A simple calculation, which takes fees into account, can help you to determine the true cost of a deal over a given period:

(monthly payment) × (no. of months) + (total fees) 

= true cost

Let's use this Post Office fixed rate mortgage as an example:

We need to calculate the true cost over the fixed period of two years. For a £120,000 mortgage with an LTV of 60%, the monthly payment is £460.44, and the fees are £1,995. So the calculation looks like this:

£460.44 × 24 = £5,525.28 (amount in payments over two years)

£5,525.28 + £1,995 = £7,520.28 (total amount over two years including fees)

Repeating this calculation for other deals will give you a better indication of what each deal will cost you over the fixed period.

Conclusion so far: the best mortgage is the one with the lowest true cost during the period you are looking at for comparison.

Reason #2: You can only compare as far as costs are fixed

The most popular type of mortgage at the moment is the fixed rate mortgage. Almost two thirds of enquiries to our mortgage tables are for this type. It's easy to see why, with bank base rate expected to rise in the near future.

And if you're like most people who opt for fixed rate, you like to keep your costs predictable, so you intend to switch again when your fixed rate expires.

To achieve this, you might fix for 2 years at a time, several times in a row. Or you might fix every 5 years. Or perhaps you'll fix for 10 years at a time.

But these different lengths of deal have different initial rates. Generally, the shorter the fix, the lower the initial rate. For example:

Rates correct at time of publication. See today's rates

So how do you compare which of these options will ultimately give you the most benefit for the lowest cost?

You need to look at what those "chunks" of cost might add up to. Would that 10 year mortgage at 3.24% be a better bet than a 2 year mortgage that costs £68 a month less initially? It's hard to answer. What kind of fixed rates will be on the market in 2 years or 5 years' time?

This is where there is no magic bullet to compare. It's down to your gut feel of where the market is going and what your situtation might be a few years down the line. Will it bother you if your next 2 year fixed rate is higher than the 10 year rate you could have locked down right now?

If you want to get a long-term fix and essentially bet against the cost of remortgaging a few times over, take a look at our 10-year fixed rate mortgage comparison table.

Compare 10 Year Mortgages

See today's 10 year fixed rate mortgage deals. Compare interest rates and reserve your deal today.

Reason #3: Eligibility matters

Ultimately, a low advertised rate is wasting your time and attention unless you can actually get approved on it.

Since April 2014, lenders have been required to introduce new, stricter affordability checks (our guide explains what lenders are looking for, and how you can boost your chances).

But in practice, different lenders use different affordability criteria. So even if two deals have the same rate, you may not be eligible for both.

For example, if you're likely to be making mortgage payments after age 65, some lenders will refuse to lend to you at all – while others will simply require evidence that you're saving for retirement.

This is where using a mortgage adviser can help. If you think it might not be straightforward for you to pass the affordability checks, or you don't want to spend hours on the phone to different providers, consider using an adviser. They can approach lenders for you, as well as finding you the best deal you can realistically hope to get.

The bottom line

Although headline rates are a great indicator of market trends as a whole, when it comes to finding the right deal for you, they're only the tip of the iceberg.

When comparing deals, remember to:

  • Calculate and compare the true cost
  • Take into account the length of time you'll stay with the deal for
  • Make sure you're eligible for the deal you're looking at, and use an adviser if you need to

Now you know what to look for, take a look at some of today's best deals: