Mortgages
Comparing Mortgages Properly: Looking Beyond the Headline Rate
When comparing mortgages, many borrowers focus only on the quoted interest rate. In reality, mortgage pricing is a combination of several different components — some expressed as percentages, others as fixed cash amounts. To make sensible comparisons, everything needs to be converted into a common format.
A good starting point is to compare mortgages with the same fixed period, for example two-year fixed mortgages against other two-year fixed mortgages.
The problem: mortgages combine “relative” and “absolute” pricing
Mortgage offers typically contain a mixture of:
Relative pricing:
Interest rate
Arrangement fee expressed as a percentage
Discount to standard variable rate
Absolute cash amounts:
Cashback on completion
Free legal work
Free valuation fees
Flat arrangement fees
These are not directly comparable.
For example:
Mortgage A may offer a lower interest rate but no cashback
Mortgage B may charge a slightly higher rate but offer £1,000 cashback and free legal fees
To determine which is genuinely cheaper, all benefits and costs need to be converted into an equivalent interest-rate adjustment.
Converting cash incentives into an equivalent rate
The principle is straightforward.
If a lender gives you £1,000 cashback on a £200,000 mortgage, that is economically equivalent to reducing the interest cost by:
[
\frac{£1,000}{£200,000} = 0.5%
]
However, that benefit applies over the life of the fixed-rate deal, not just one year.
For a simple approximation, you can spread the benefit evenly across the fixed term:
0.5% benefit spread over a 2-year fixed deal
Equivalent to roughly 0.25% per year
So a mortgage charging 4.25% with £1,000 cashback might be economically similar to a mortgage charging roughly 4.00% with no cashback.
Why the precise calculation is slightly more complex
In reality, mortgage balances reduce over time as repayments are made, meaning the average outstanding loan balance is lower than the starting balance.
Because of this, finance professionals typically use a concept called duration to calculate the true economic effect of upfront incentives and fees.
Duration measures the average time over which cashflows occur. It allows upfront cash amounts to be converted more accurately into an annualised equivalent interest-rate adjustment.
For most retail mortgage comparisons, a simplified approach is usually sufficient, but the underlying principle is important: upfront cash incentives should not simply be ignored.
Mortgage size matters
One important consequence of this framework is that the “best” mortgage often depends on the size of the loan.
A fixed cashback amount has a much larger effect on a smaller mortgage than on a larger one.
For example:
£1,000 cashback on a £100,000 mortgage = 1.0% of the loan
£1,000 cashback on a £1,000,000 mortgage = 0.1% of the loan
This means:
Smaller borrowers may benefit more from cashback-heavy products
Larger borrowers may care far more about small differences in interest rate
A seemingly attractive cashback offer can therefore be economically insignificant on a large mortgage.
Loan-to-value (LTV) also matters
Mortgage pricing varies heavily by loan-to-value ratio (LTV).
Some products are only available below certain thresholds such as:
60% LTV
75% LTV
85% LTV
90% LTV
Even a small reduction in borrowing can sometimes move a borrower into a better pricing bracket and materially reduce the effective borrowing cost.
As a result, proper mortgage analysis always depends on:
Loan size
Property value
LTV ratio
Mortgage term
Expected holding period
What about overpayment and early repayment flexibility?
Many lenders market flexible repayment terms as a major benefit.
Examples include:
Ability to overpay up to 10% per year
Reduced early repayment charges
Offset features
Flexible redraw facilities
These features do have value — but often less than marketing materials imply.
The economic value of overpaying a mortgage depends primarily on the difference between:
The mortgage interest rate saved
The after-tax return available on cash savings elsewhere
For example:
If mortgage interest costs 4.5%
But cash savings inside an ISA earn 4.0% tax-free
The true benefit of overpaying may only be around 0.5% per annum
Once tax shelters such as ISAs are considered, the financial advantage of aggressive mortgage prepayment can become surprisingly modest.
In many cases, repayment flexibility is psychologically attractive rather than economically transformative.
That does not mean flexibility is worthless — particularly for borrowers with uncertain income or future plans — but its value should be assessed realistically.
Reducing every mortgage to a single “all-in” rate
Our approach is to convert every mortgage product into a single comparable figure:
The effective all-in interest rate
This incorporates:
Interest costs
Cashback
Fees
Free incentives
Flexibility features where measurable
Once everything is converted into a common economic framework, products become much easier to compare objectively.
Comparing different fixed terms: 2-year vs 5-year fixes
Comparing mortgages with different fixed periods introduces another layer of complexity.
A 5-year fixed mortgage will normally have a higher rate than a 2-year fixed mortgage — but that does not necessarily mean it is “more expensive”.
This is because longer-term interest rates are naturally higher or lower depending on market expectations and funding costs.
To assess relative value properly, mortgage rates should be compared against the underlying interest-rate swap curve for the same maturity.
In simple terms:
The swap curve represents the market cost of fixed-rate funding over different periods
It acts as the wholesale benchmark underlying mortgage pricing
For example:
If 5-year market funding rates are significantly above 2-year funding rates, a higher 5-year mortgage rate may actually represent better value
Conversely, a seemingly low mortgage rate may actually be expensive relative to underlying market pricing
This allows us to distinguish between:
Absolute mortgage rates
Relative value versus prevailing market conditions
The key point
The cheapest mortgage is not necessarily the one with:
The lowest headline rate
The largest cashback
The lowest fees
It is the mortgage with the lowest overall economic cost once all features are converted into a common comparable framework.
Advice
When remortgaging start early. You can always cancel and reapply if rates fall. In effect you are long an option without paying for it. See Merryn podcast
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