If there is a bone of contention in the mortgage in-dustry that unites and divides lenders, brokers and borrowers in equal measure it is arrangement fees.
These days, borrowers barely bat an eyelid over arrangement fees of 495 or percentage fees of anything up to 4%, leaving brokers to bemoan the seemingly unstoppable rise of these fees and struggle to find justifications for them, while lenders defend them as rightful and fair.
To some extent, lenders’ defence could be accepted as fair, given the positives apparent in the market such as the vast product choice that is now available.
And lenders have to cover their costs, particularly in an increasingly competitive market which has seen a tightening of profit margins.
But it’s still hard to swallow the rise of arrangement fees.
“Even 18 months ago, arrangement fees were nowhere near what they are James Cotton is mortgage specialist atLondon & Country The role that arrangement fees play as part of mortgage deals has changed considerably over the past couple of years. now,” says Mike Halton, managing director of Merseyside-based Halton Financial Services.
“Mortgages tend to be for higher amounts now and when you look at the arrangement fees lenders slip in at around 2%, they are quite hefty.
“Arrangement fees are rip-offs, for want of a better word, and lenders are just adding them to loans.
“A borrower might start out needing a loan of 100,000 but this instantly becomes 102,000 because of the arr-angement fee,” he adds. “Lenders are getting their money back for the lower interest rates they are charging by adding these whopping fees on.”
What do lenders have to say about their arrangement fees, how do they relate to broker proc fees and is a cap on fees in order? The consensus seems to be that when a client pays an arr-angement fee it should be seen as part of a wider package.
“An arrangement fee is just one element of the overall pricing of a mortgage deal, along with the interest rate and any other fees and charges – i.e. higher lending charges, which we do not charge,” says a spokeswoman for Nationwide.
“It is important that borrowers compare all elements of deals when choosing mortgages rather than base their decisions on arrangement fees or interest rates in isolation.”
A spokeswoman at Chelsea agrees.
“The fee is a part of the overall de-sign of a product and helps determine the charging structure,” she says.
“Effectively the fee and the interest add up to the charge for borrowing the money.”
Arrangement fees allow lenders to discount incentive rates, says Nici Audhlam-Gardiner, head of mortgages at Abbey.
“Most lenders offer ranges of products which allow customers to choose what is best for them,” she says.
“The amount they wish to borrow will drive the decision as to whether taking a mortgage with a low incentive rate but a high fee is cost-effectivefor them in terms of the total am-ount to be repaid.
“It also depends on whether a customer has sufficient funds to pay an upfront fee, although in most cases this can be capitalised,” she adds.
Andy Wiggans, mortgage products director at Bradford & Bingley and its specialist subsidiary Mortgage Exp-ress, agrees that fees are part of overall deals, and adds that borrowers are free to choose how they pay them – as arrangement fees or in the form of higher rates.
“All core MEX deals offer an alternative to high fees – either a 599 fee or in some cases no fee,” he says.
“These products will generally have higher pay rates. High fee, low rate deals are particularly popular in the buy-to-let market where the fact we calculate rental cover on pay rate rather than a nominal base-plus-something rate means landlords can arrange mortgages on properties where rental cover is tight.”
But how can an arrangement fee of more than 900 or 2% of a loan be justified?
“Deals with higher fees have lower rates of interest and can offer better value to clients with larger mortgages,” says Nationwide’s spokeswoman.
“We offer a range of mortgage deals, from products with no fees to ones with fees of 1,999.”
Wiggans is equally defensive.
“As a fee is effectively part of the price of a loan, I don’t see why it has to be justified,” he says. “An arrangement fee forms part of the price of a deal – high fee, low rate or low fee, high rate.”
Philippa Colley, managing director of North Yorkshire-based Pure Mortgage Solutions, is concerned about the potential for lenders to raise their arrangement fees in line with base rate hikes.
“One of my worries is when lenders use interest rate changes as an excuse to increase all their related fees,” she says.
“If there is a 0.25% rate rise, you would expect lenders to be withdrawing their products and bringing them back with anything from a 0.2% to 0.3% rate rises.
“But what you don’t expect them to do is to withdraw products and bring them back with a 0.25% rate rise and double the arrangement fee,” Colley adds.
That said, there is no correlation between higher arrangement fees and higher proc fees.
“Higher arrangement fees do not correspond with higher proc fees,” says Nationwide’s spokeswoman.
“Like other lenders, we pay proc fees based on a percentage of the mortgage balance. This fee is the same re-gardless of whether the deal has no Andrew Strange is a policy analyst at the Association ofMortgage Intermediaries Take a look at what is happening in the mortgage market when it comes to arrangement fees and it will soon become apparent they are on the up. Historic fee levels of between 199 and 250 are being replaced with fees of 1,999 or 2.5%. arrangement fee or a large one.”
Similarly, a spokesman for Cheltenham & Gloucester says it has recently increased the proc fees on its buy-to-let products while the arrangement fees on the deals have remained unchanged.
“Higher arrangement fees bear no relation to proc fees because the return on a deal is fairly comparable whether the broker sells a high, low or no fee product,” says Wiggans.
“The introduction of higher fee deals has been a reflection of consumers’ and brokers’ desire to keep monthly payments as low as possible. Proc fees have nothing to do with it.”
O’Connell says Chelsea uses a standard scale of proc fees that has no relation to arrangement fees.
But at what point do brokers have to start charging more for their work to reflect the time it takes to sift through the huge number and variety of rates, arrangement fees and product features on the market?
Of course, it could be argued that this is part and parcel of brokers’ jobs but even with sourcing systems it is becoming an increasingly onerous and time-consuming task.
“I agree that brokers spend more time working out which are the best deals, these days,” says Colley. “That means an additional cost for brokers, which means they can justify charging fees for their services.
“But you have to ensure that if you are doing this, you are professional and ethical about it, and that it is cost-effective for your clients.”
Colley says it’s a case of brokers establishing trust with their clients.
“If you have done thorough fact-finds and built up relationships, your clients will trust you to do the best for them by looking across the whole market,” she says. “You have to deliver on that trust.”
It’s also about managing client ex-pectations – something else that falls on brokers’ shoulders.
“Clients will see low interest rates bandied about without being aware of arrangement fees,” says Colley.
“We have to manage clients’ expectations if we are going to them with deals that have higher interest rates but are cost-effective because they have lower fees. This is fine for brokers be-cause we understand the market but it’s more difficult for clients because it can be confusing.”
And the difficulty of advising clients about the best deals is compounded by the attraction of low headline rates. Consequently, brokers have double the work to do.
“You have to be better prepared,” says Halton. “Effectively, you now have to do two mortgages for each client – a non-arrangement fee one and an arr-angement fee one.
“And given that people push themselves to the limit in terms of affordability, you then have to consider whether they would be able to pay their mortgage if the rate went up 2%. So you end up doing a third mortgage calculation to show them what the consequences of extremes might be. You have to bring clients down to earth and show them the pitfalls of deals.
“I sometimes wonder how lenders can justify arrangement fees of 3,000 when their pay rate is only 0.5% less than everyone else,” he adds.
“You could be cynical and say if they are saving 70 more a month, the arrangement fee should be 1,500. But the trouble is that people go for those fees. If they shopped around they could probably get better deals.”
So if the market campaigned for len-ders to cap arrangement fees and succeeded, what would happen to charges? Some lenders concede the cost would be felt elsewhere.
“Fees form part of the overall pricing of mortgage deals and a cap on arrangement fees might make it im-possible to offer such competitive interest rates,” Nationwide’s spokeswoman says.
Abbey’s Audhlam-Gardiner agrees.
“There would be no change in char-ges as this fee is not a charge but rather a part of the upfront pricing of products,” she says.
“If fees were to be capped, the effect would be that rates would not be available to customers at the price they are now. For some customers, it’s better to pay a high fee and take the reduction in interest rate. Restricted fee options allow for more choice in the market.”
Interestingly, the Council of Mortgage Lenders declines to comment on the arrangement fees debate.
“We don’t have a stance on arrangement fees,” says a spokesman for the trade body. “We simply try to promote the most favourable operating environment for lenders which we believe is one that allows them maximum freedom in determining their pricing structures. They then have to justify these to their customers and the market more widely.
“We don’t monitor fees, so we have no data regarding what’s happening in the market.”
But in March this year, Mortgage Strategy reported that the CML had de-fended lenders that charge high arr-angement fees on low interest rate products following criticism from a number of members of Parliament.
In an early day motion, a group of MPs accused lenders of taking advantage of consumers by charging high arrangement fees on products with low rates.
“High arrangement fees are being used to subsidise low headline interest rates so as to ensure that mortgage pro-ducts appear in best buy tables, even where such mortgages are not the best buys once account is taken of the fees Nicola Severn is head of public relations at edeus With theincreased focus on treating customers fairly, it’s no surprise that arrangement fees are in the spotlight. charged,” the motion stated.
“There is nothing inherently wrong with lower rate, higher fee products, which may be the right choice for people wanting to borrow large sums of money,” a spokesman for CML said at the time.
“The key is to have in place compliant selling practices under the Financial Services Authority’s regime. We would not support constraints on product design or price controls.”
Lenders don’t anticipate interference on fees from the regulator.
“I can’t imagine a situation where-by arrangement fees could or would be capped by statutory regulation, as this would be seen as being an attempt to regulate pricing in the market, which the FSA has stated it has no desire to do,” says Wiggans.
So it seems that market forces will determine the level of arrangement fees outside of the regulator’s remit. This means brokers will have to vote with their clients’ feet and continue to sniff out the best fee options relative to interest rates.
As for aligning brokers’ fees to re-flect their work, it comes down to the same two principles that should underpin every broker’s business – transparency and professionalism. •
Brokers can help as fee changes make the market more complicated
James Cotton is mortgage specialist at London & Country
The role that arrangement fees play as part of mortgage deals has changed considerably over the past couple of years.
In fact, the continuing rise in house prices, relatively low and stable interest rates and the increasingly competitive mortgage market have meant that almost all aspects of product design and criteria have been reviewed, scrutinised and improved where possible. We have seen this with income multiples, LTV limits, rental calculations and age limits as well as arrangement fees.
Traditionally, arrangement fees were not closely associated with interest rates. They tended to be consistent across lenders’ ranges and be used to cover initial costs and processing. But now they are a more integral part of the design and pricing of products rather than simple administration fees.
The practice of tweaking products by balancing rates and fees first became widespread in the buy-to-let market. It allowed lenders to reduce rates and improve their rental criteria without eroding their margins – necessary due to house price growth outstripping growth in rental income.
We have also seen the increasing use of percentage fees for the same reason. This is the most obvious way of balancing rates and fees.
The rising arrangement fee phenomenon has since moved to the residential market and we now see many deals with fees in excess of 1,000, and many others with percentage fees.
While there is no doubt that average arrangement fees have risen recently, it has to be said that most high fee deals complement standard deals rather than replace them. Also, a wide range of fee-free deals are still available.
In many cases, the result is a broad menu system whereby lenders offer a range of rate and fee combinations designed to cater for the full spectrum of borrowers. Ultimately, this means more choice for borrowers, which has to be a good thing.
It also means that choosing the right mortgage can be a daunting task and it’s important that borrowers aren’t drawn in by attractive-looking rates without factoring in other costs. Of course, this provides good opportunities for brokers who are well placed to assess and compare the costs of various deals.
The general rule is the higher the loan, the more worthwhile it is paying a higher arrangement fee in return for a lower rate, but this doesn’t stack up when it comes to percentage fees.
Borrowers have the option of adding these fees to their loans, which can help in terms of cash flow. And here is another example of where brokers can help, by explaining the pros and cons of such tactics. It may feel like clients are getting great rates for free, but adding fees to loans will cost more in the long run.
Fees add a new dimension to product ranges
Andrew Strange is a policy analyst at the Association of Mortgage Intermediaries
Take a look at what is happening in the mortgage market when it comes to arrangement fees and it will soon become apparent that they are on the up. Historic fee levels of between 199 and 250 are being replaced with fees of 1,999 or 2.5%.
There are a number of reasons for this. First among these is that lenders want their headline rates to top best buy tables and given rising base and swap rates, raising arrangement fees to subsidise product rates achieves this goal. Innovation in the buy-to-let sector has also contributed to fuelling demand for such mortgages.
In principle, assuming the advent of these products adds a further dimension to the product offerings of lenders rather than replacing their existing ranges, this development has the potential to add value. A client with a small mortgage could benefit from a high percentage fee while a client with a larger mortgage could benefit from a high flat fee. Choice is key, and fee innovation and the increased competition and product variety this brings can only be beneficial for customers.
But there is the potential for customer confusion due to the variety of products available. This highlights the need for advice from professionals who have the knowledge and ability to source the best deals.
We acknowledge that brokers need to take care when recommending high fee, low rate mortgages. They must fully document the reasons for their recommendations and clearly identify their clients’ priorities – initial monthly cost or true total cost over the duration of the preferential rate period.
Clients also need careful guidance when considering adding these fees to their loans. Of course, this will incur interest. Brokers should alert their clients to the potential cost of such loans if they are redeemed earlier than anticipated in which case clients won’t benefit from lower interest rates for the full preferential period.
Customer confusion can make justifying these arrangements more challenging for brokers. But we believe professional brokers have sufficiently strong relationships with their clients to be able to explain the trade-offs as part of the advice process.
In the buy-to-let market, downward pressure on rental yields combined with increasing interest rates and the availability of higher LTV mortgages means that some landlords are struggling to make profits from their investment properties. By taking out mortgages with high arrangement fees, investors can benefit from artificially low rates improving their cash flows but can potentially capitalise the cost of this, taking some pressure off impending Capital Gains Tax liabilities.
As interest rates continue to rise, we expect to see a continuation of this trend and as long as advice is sought by clients and lenders’ product ranges remain diverse, we consider increased choice and the encouragement of innovation to be a good thing for the industry.
With fees, it’s transparency that matters
Nicola Severn is head of public relations at edeus
Not so long ago, exit fees were in the frame, with much of the media debate being fuelled by the Financial Services Authority’s scrutiny of lenders’ mortgage repayment charges so it is not surprising that arrangement fees are also making their way up the agenda.
As with exit fees, arrangement fees are widely accepted by professionals in the market. They understands fees’ importance as part of the product pricing model. Arrangement fees are important in producing pricing flexibility and thus product choice, so the issue is not the existence of fees but rather their transparency.
With many financial products, fees are a fact of life and borrowers accept that they are an intrinsic element within mortgages too. Provided borrowers are aware of the fees they will be charged and the structure of those fees is easy to understand, informed product choices can be made taking into account all pricing elements. It’s only when fees are not communicated clearly that their existence becomes a problem.
It is worrying that consumer promotions rules don’t require arrangement fees to be printed in the same size font as headline rates. Some high street lenders have been known to take advantage of this, disguising hefty fees at the bottom of adverts and enticing potential borrowers with attractive headline rates.
It’s worrying that borrowers can be misled in this way and further highlights the importance of good quality, professional advice. Arrangement fees play an important role in the market and are undoubtedly here to stay, but the regulator would be well advised to clamp down on high street lenders that use promotional loopholes to hoodwink borrowers.
Potential borrowers must be aware of all the pricing elements in products so they can make informed choices from a viable range of options. Ultimately, lenders that direct their promotions at consumers and communicate their fees in a less prominent way than their rates will be seen as not treating their customers fairly.