When is cheapest actually cheapest?
Just under four weeks ago, Mervyn King sang his swan song as the governor of the Bank of England. The speech he gave to mark his departure was about what we expected: words to the effect of “we’re getting there, but aren’t there yet, and we shouldn’t take this as ‘the beginning of the end’.”
He was referring to the announcement that the Federal Reserve Bank in the US is planning to start scaling back its quantitative easing measures. Lord King observed that we shouldn’t start raising interest rates too quickly, but nevertheless, a spike in the swap rates followed the Fed’s announcement, and it quickly became news that we might be seeing the end of our ‘low rate’ honeymoon. A rise in the Bank of England base rate might not be imminent, but individual lenders might be more trigger-happy with their standard variable rates – at least, so the experts warn.
Rental yields are far lower than they were prior to the recession, and tenants’ incomes put a roof on the rents landlords can realistically charge. Most of the money you save will be by choosing the right mortgage, and recent announcements might have had you shopping around for a remortgage; but how can you tell which mortgage is the cheapest, and – perhaps more importantly – is ‘cheapest’ actually ‘best’?
Can you tell the cheapest mortgage?
Recently, the consumer campaigning charity Which? asked around 1,000 mortgage and remortgage customers if they could correctly rank five mortgages in terms of how cheap they were over the initial two-year period. The APR (annualised percentage rate) was there to throw them off the scent, and many of them took the bait – only around a third correctly identified the cheapest, and a staggering half a percent managed to rank all five. This is despite half of the respondents saying the test was ‘easy’.
Now, professional investors such as landlords might be better equipped to find a more competitive deal, but there’s still a lot to take into account. Here are some examples of products currently on the market, based on a pure interest-only, £100,000 buy to let remortgage, with an initial two-year deal and 25-year term:
Total interest to pay
Number four would top the rates tables and get the attention of many borrowers, but as you can see, what works out as the cheapest mortgage in the long term (by over £10,000) is actually 0.70% more expensive at the outset. In fact, it has the highest initial rate of the five.
The APR is in line with how expensive the mortgages are over the term, but it is important to remember that this figure is only a projection; base rate changes cannot be predicted, especially over a long period, and this figure is therefore best placed to compare the value of different mortgages at the outset.
It’s all down to your circumstances
In reality, which mortgage is ‘best’ is not cut-and-dry, and the important thing is not to look at any one aspect in isolation. The APR is a good figure to use for initial comparisons, but is only a reflection of what the interest rate may actually do over the lifetime of the loan. A large fee may add to the upfront costs, but there may be other features of the loan (such as its flexibility or availability to borrowers with adverse credit) that make it worthwhile in some instances.
The initial rate is important, particularly as you may still be reeling from the large initial outlay required for a mortgage, but the shorter the initial term, the less of an impact it has on the total cost of the mortgage. You are likely to pay the reverting rate for longer, but this figure is likely tied to a variable rate and could change with little warning.
Even the ‘total to pay’ figure becomes less representative over a longer term, as overpayments, rate changes and other factors are taken into consideration. Additionally, it might be your plan to switch your buy to let mortgage on a regular basis – in this case, fees and initial rates will be your primary concern.
The features of the mortgage are just as important as its cost. How long is the initial term? Can you make overpayments or switch without penalty? To what base rate is the tracker and/or reverting rate tied, and what provisions are there to mitigate the damage of potential rate hikes in the future?
Some borrowers will want flexibility whilst some will want stability, and others will want to reside somewhere in the middle ground. What mortgage is right for you depends more on your circumstances, and your short- and long-term aspirations for your business, than it does on what mortgage seems like the ‘cheapest’.
By Ben Gosling
TurnKey Landlords is a specialist buy to let mortgage broker with access to the whole buy to let market. They look at the whole picture, including your circumstances and plans for your investment, when sourcing the right mortgage for you.