Should I pay an arrangement fee to get a cheaper rate?

Mortgage products come in various forms, including those with fees and those without, as well as options that offer cashback and other incentives. The choice that suits you best depends on your personal preferences, circumstances, the size of the loan, and the specific mortgage product. This guide aims to provide a comprehensive understanding of the different aspects involved, helping you make an informed decision based on your needs.

What is a mortgage arrangement fee?

A mortgage arrangement fee is a one-time charge that borrowers pay to their mortgage lender when taking out a mortgage loan. It covers the administrative costs associated with setting up the mortgage. The fee can vary in amount but is typically a percentage of the loan amount.

Mortgage products with arrangement fees often offer lower interest rates compared to those without fees. Lenders may offer reduced rates to incentivise borrowers to choose mortgage products with arrangement fees, as these fees help offset the cost of providing the loan. 

How much are mortgage arrangement fees? 

Mortgage arrangement fees can vary depending on the lender and the specific mortgage product. The fees typically fall within a range of options, including:

1. None: Some mortgage products may have no arrangement fee.
2. Fixed amount fees: Common arrangement fee amounts can be around £499, £999, £1,499, or £1,999. These fixed fees are predetermined by the lender.
3. Percentage-based fees: In some cases, the arrangement fee may be calculated as a percentage of the mortgage balance. The percentage can vary depending on the lender and the mortgage product.

How do you know which one is best for you?

The worth of paying an arrangement fee on a mortgage depends on several factors. Here are some key considerations:

• Interest rate: If the mortgage with an arrangement fee offers a significantly lower interest rate compared to fee-free alternatives, it could result in long-term savings that outweigh the upfront fee.
• Loan amount: The impact of the arrangement fee on the overall cost of the mortgage depends on the loan amount. For larger loans, even a slightly lower interest rate can lead to substantial savings over time.
• Duration of the mortgage: The longer the initial rate period, the more time there is for the lower interest rate to offset the arrangement fee. For example, you chose a Product with a £999 fee , if you save £40 per month compared to one without a fee, you would save £960 in monthly payments over a 2 year fixed rate (24 payments) or on a 5 year £2,400 (60 payments)
• Financial circumstances: Your financial situation, including income, expenses, and cash flow, should also be taken into account. If the arrangement fee places a significant burden on your budget or affects your ability to cover other costs, it might be more prudent to choose a fee-free mortgage.
• Comparison of overall costs: To make an informed decision, compare the total costs (including fees and interest) of different mortgage options over the entire term. Consider using mortgage calculators or consulting with a financial advisor to evaluate the long-term cost implications.
• Monthly payment preference: If your priority is to have the lowest monthly payments, even if it means paying more overall, then a mortgage without an arrangement fee may be more suitable. This approach prioritises short-term affordability over long-term savings.

Example of fee versus no-fee product

Let’s compare the cost of adding a mortgage arrangement fee to the loan versus opting for a no-fee option.

Product 1: £300,000 mortgage at 3.5% over 25 years on a 5 year fixed rate with a £999 arrangement fee:

• Monthly payment: £1,502

Product 2: £300,000 mortgage at 4% over 25 years with no arrangement fee (5-year fixed rate):

• Monthly payment: £1,584

The difference in monthly payments between the two scenarios is £82. Over the course of a 5-year fixed-rate period (60 months), the total savings amount to £4,920 (£82 per month x 60 months).

To calculate the net saving, we subtract the £999 arrangement fee from the total savings: £4,920 – £999 = £3,921.

Therefore, by opting for the 5-year fixed rate with a slightly higher interest rate but no arrangement fee, you would save a net amount of £3,921 over the fixed rate period compared to the option with the arrangement fee.

Can a mortgage arrangement fee be added to the mortgage?

Yes, it is possible to add an arrangement fee to a mortgage in most cases. However, there are certain conditions that must be met, including affordability and loan-to-value considerations.

In certain cases, the lender may have restrictions on adding an arrangement fee to the mortgage based on affordability and loan-to-value (LTV) criteria.

Suppose you are purchasing a property for £100,000, and your affordability assessment determines that you can only borrow a maximum of £90,000. In this scenario, you would not be able to add an arrangement fee to the mortgage because it would exceed the amount you are eligible to borrow.

If the lender’s arrangement fee is, for example, £1,000, adding that fee to the mortgage would increase the loan amount to £91,000 (£90,000 loan + £1,000 fee), which is higher than your borrowing capacity of £90,000. Therefore, you would need to pay the arrangement fee separately rather than including it in the mortgage.

Is it worth adding a fee?

Deciding whether to add an arrangement fee to the mortgage or pay it upfront involves weighing various factors. Here’s a consideration of the trade-offs:

Adding the arrangement fee to the mortgage:

Pros:

• Cash flow preservation: Adding the fee to the mortgage allows you to spread the cost over the loan term, preserving your immediate cash flow and keeping your savings intact.

Cons:

• Interest on the fee: When the fee is added to the mortgage, you’ll be paying interest on it over the loan term. This increases the overall cost of the fee compared to paying it upfront.

Paying the fee upfront:

Pros:

• Immediate cost savings: Paying the fee upfront avoids the additional interest charges associated with adding it to the mortgage, resulting in lower overall costs.

Cons:

• Depleting savings or cash flow strain: Paying the fee upfront requires a lump sum payment, which may deplete your savings or strain your cash flow.

To make an informed decision, consider your financial situation, including available savings and monthly cash flow. If paying the fee upfront puts you in a precarious financial position, adding it to the mortgage could be a more prudent choice. However, if you can comfortably afford to pay the fee upfront, it may save you money in the long run due to the avoidance of interest charges.

When is a mortgage fee payable?

A mortgage fee is typically payable during the mortgage application process. The specific timing of when the fee is due can vary depending on the lender and the terms of the mortgage agreement. Here are some common scenarios:

• Added to the mortgage: In some cases, the arrangement fee can be added to the mortgage amount. This means the fee is included in the total loan amount and paid off over the mortgage term. If you choose this option, the fee will be payable upon completion of the mortgage.
• Paid on application: Many lenders require the arrangement fee to be paid upfront at the time of application. This ensures that the fee is settled before the mortgage process progresses further.
• Paid before completion: Alternatively, the fee may need to be paid a few weeks before the completion date. This timeframe allows the lender to receive the fee and finalise the necessary arrangements before the exchange of contracts.

The specific timing will depend on the lender’s policies and the mortgage agreement.

Short versus long-term fixed rate fees

If you consistently choose short-term mortgage products, such as 2-year fixed rates, that come with arrangement fees, those fees can accumulate over time and increase the overall cost of your mortgage.

If you were to pay a £1,000 fee every two years over a five-year period, the total fees paid would amount to £3,000.

On the other hand, opting for a longer-term mortgage, such as a 5-year fixed rate, can help you avoid paying multiple arrangement fees within that period. This can result in lower overall fees compared to the cumulative fees paid with shorter-term mortgages.

It’s important to consider the trade-offs between upfront costs and long-term savings when choosing mortgage products. Assessing factors such as the interest rate, flexibility of the mortgage terms, and your future plans is essential.

Are mortgage arrangement fees payable when you Remortgage?

Yes, mortgage arrangement fees can also be applicable when you remortgage. When considering a remortgage, you typically have options with and without fees. It’s essential to assess the overall cost to determine which option is cheaper.

How much does it cost to add a mortgage arrangement fee to the loan?

The cost of adding a mortgage arrangement fee to the loan varies depending on the mortgage term and interest rate. Typically, the arrangement fee is added to the total loan amount and spread out over the mortgage term, resulting in a slightly higher monthly payment.

Using a £1,000 arrangement fee at a 3.5% interest rate over a 25-year mortgage term, the approximate cost per month would be around £5.

To get a more accurate calculation, you can use a mortgage calculator that allows you to input the loan amount, interest rate, and term. By adding the arrangement fee to the loan amount, you can determine the resulting monthly payment.

Should I choose a mortgage product with an arrangement fee?

The decision of whether to choose a mortgage product with an arrangement fee is an individual one that depends on your specific options and preferences. Speaking with a mortgage broker can provide valuable insights and guidance, helping you understand the available options and make an informed decision.

For more information on arrangement fees, please contact a member of the Strive team, by emailing info@strivemortgages.co.uk or call us on 01273 002697.