When it pays to be upfront

Pay a large sum to arrange your mortgage and you could win in the long term

Can it pay to pay several thousand pounds to arrange a mortgage? This is the question posed by several current home loan deals. Instead of a lender's arrangement fee of a few hundred pounds, a growing number of mortgages attract fees of between £1,000 and £2,500. This fee is on top of any legal charges, valuation fees, and any fees charged by a mortgage broker.

Bank of Scotland levies a fee of £2,500 for a tracker mortgage, offering a discount to the Bank of England base rate of 0.61 per cent until December 2007. At current rates, that means home buyers will pay 3.89 per cent for their loans. Until last week, lender BM Solutions had a two-year tracker deal, at 3.75 per cent, with a £1,499 arrangement fee.

For a fixed-rate mortgage, BM Solutions offer a rate of 4.09 per cent until January 2008, again with a £1,499 fee, whilst Cheltenham and Gloucester is charging a £999 fee for a mortgage at 4.69 per cent until the end of November 2008.

Paying such large fees up front can be worthwhile. "For a larger mortgage, a high fee can work out in the long run," says Melanie Bien, associate director at mortgage brokers Savills Private Finance.

Exactly how large the mortgage needs to be depends on the arrangement fee, the interest rate, and the length of any fixed rate or discounted period. The BM Solutions mortgage, with its very low interest rate of 3.75 per cent, will have been worthwhile for home buyers looking to raise £100,000 or more.

But some high fee mortgages only start to make sense for people borrowing twice as much - such as the Bank of Scotland tracker, where borrowers are tied in beyond the two-year discount period.

It is important to analyse all the elements and costs. Some fixed and discount mortgages are for an exact number of years from completion, but others have a fixed end date. If the end date is 20 months rather than two years away, a buyer has to set the cost of the higher arrangement fee against 20 months' repayments, rather than 24.

It is important to work out whether a high arrangement fee will pay for itself purely during the fixed or discount rate period. Unless the loan reverts to a tracker mortgage, there is no way of knowing whether the lender's rates will be competitive at the end of the deal.

Such calculations are not always easy to make using best buy tables, so home buyers considering a high-fees mortgage should consider going to a broker.

"Not all lenders have mortgages with very high fees," says Ray Boulger, senior technical manager at brokers John Charcol. "But we are seeing increasing variety."

A handful of lenders also offer mortgages with arrangement fees that are based on a percentage of the mortgage amount. On paper, such deals will be a better prospect for those wanting smaller mortgages. But the percentage fees currently on offer will work out more expensive than many lenders' standard, fixed fees.

John Charcol has a "shared exclusive" mortgage at Bank of England base rate plus 0.24 per cent for the lifetime of the loan; this currently works out at 4.74 per cent. The arrangement fee is one per cent.

For a £100,000 mortgage, this equates to a fee of £1,000. But for those looking for smaller sums the fee starts to fall into line with many lenders' fixed fees for discounted trackers.

Northern Rock has a two-year fixed rate of 3.99 per cent, but with a fee of 1.5 per cent. The catch is that the minimum mortgage for this deal is £100,000. This gives a minimum fee of £1,500, making it the second highest fee on the market.

The best way to see if such deals are cost effective is to equate the fee with a higher interest rate. For the Northern Rock deal, as it is a two-year fixed rate, the 1.5 per cent fee brings the equivalent interest rate to 4.74 per cent: by no means the best on the market.

"For a five-year fix, a 0.5 per cent arrangement fee works out at 0.1 per cent on the rate; for 10 years it works out at 0.05 per cent," says John Charcol's Ray Boulger.