How the hard facts undermine the case for 'cut-price' loans

Nothing could be simpler that choosing a mortgage. You simply pick the lender offering the best interest rates on the market, right? Wrong: as Nic Cicutti explains, taking out a loan involves more than opting for the lowest headline rate.

The past few years have seen a dramatic increase in the number of different mortages available to borrowers. Barely a week passes without at least 100 new loans hitting the market, replacing offers - some available for only a few days - considered defunct by lenders.

Choosing between them has become a lottery, a problem compounded by the proliferation of deals where the small print becomes more important than the key advantages of what is on offer.

It is no surprise that many borrowers, both first-time buyers and - perhaps surprisingly - those seeking to re-mortgage are tempted by headline rates.

These are the "teaser" advertisements that promise an ultra-low annual percentage rate (APR) to borrowers. Yet anyone who wanders blindly into the maze could find themselves paying heavily for that special deal. Before deciding on the loan, there are several points to examine.

The first is that APRs, the supposedly cast-iron mechanism for telling whether one rate from another, may be no such thing. For example, many lenders calculate their APRs on the assumption that the borrower will not necessarily revert to a standard variable rate at the end of the fixed or discounted period.

The result has been mounting confusion as lenders apply whatever figure they like in respect of what they assume borrowers will pay in the long term. It pays therefore, for borrowers to ask whether the APR relates only to the headline period or the full duration of the loan.

There are other issues to look at, one of them being the booking fee. Many lenders will charge pounds 295 to arrange the mortgage. But some will levy pounds 395, while a handful have been known to levy as much at pounds 695. At that price, the rate on offer would have to be amazing for it to be worthwhile.

Alan Mudd, sales manager at John Charcol, the UK's largest mortgage brokers, warns of another potential sting in the tail: "Look at the headline rate, coupled with the tie-in period when redemption penalties apply. If you are looking to pay off part of your mortgage early, heavy penalties if you redeem in the first five years can be a sting in the tail you don't need."

Yet many lenders still continue with a policy that imposes five-year redemption charges - such as six months-worth of interest - even for a two-year fixed rate deal.

Mr Mudd adds: "Look very carefully at the rate that is being charged for cashback morgages [where a percentage of the loan is given back to you in cash]. What tends to emerge is that you get charged a slightly higher rate for that cashback."

Jim Chadwick, marketing director at Barclays Mortgages, gives one example of the pressures involved in trying to offer a fair deal to borrowers on cashbacks: "There has been a conception that headline price equals 'best price', but with contractual lock-ins to the lender - sometimes for many years - the sting is in the tail.

"For a number of years we were caught in the trap. Simply, we were concerned that locking customers in to variable rates for long period of time could be extremely dangerous to them, particularly if rates were to increase. We therefore set a limit of two years on lock-in period. But as returns from mortgages are driven by lock-ins this meant we could not offer the same levels of cashbacks and effectively withdrew from the price wars."

Interestingly, one recent study shows that over a five-year period between April 1992 and April 1997, a pounds 60,000 mortgage would have cost pounds 22,159 in interest payments with Barclays Mortgages, whereas the supposedly more competitive Nationwide, Britannia and Bradford & Bingley charged between pounds 21,236 and pounds 24,011 over the same period.

As the facts become clearer, customers have tended to look deeper for value, many now being prepared to use to Barclays for their loans.

Alan Mudd, at John Charcol, adds: "Borrowers should also look at the issue of compulsory insurances. Everyone needs insurance, but what I recommend is that people should shop around first and get the best quote for the best home and contents policy.

"Then, they should compare it to the cost of compulsory insurance on that attractive mortgage rate. Quite often you will find that what a lender will charge for compluslry insurance equates to 0.25 per cent on the mortgage rate." On a pounds 60,000 interest-only loan, that means an extra pounds 12 a month for 25 years.

John Charcol recommends that customers also check whether mortgage indemnity guarantees (MIGs), the insurance levied from borrowers to meet sums owed in the event of default, are applied and what they are. Some lenders charge up to pounds 1,000 more than others for the same-sized loan.

As suggested last week, it also pays to find out when capital repayments are deducted from the outstanding mortgage balance: monthly or daily. The monthly option can save pounds 4,500 in interest payments on a typical pounds 60,000 loan over 25 years.

Finally, Mr Mudd advises, check the lender's track record: "If they lag behind everyone in lowering rates and race to raise them, borrowers will end up paying more, no matter what the headline rate."

Nic Cicutti, personal finance editor, has written a 27-page Guide to Mortgages, available free to readers of The Independent. The guide, sponsored by Barclays Mortgages, is available by calling 0800 585691. Or fill in the coupon on page 3.