How should you compare mortgages?

Question

There are many mortgage options available in the market, differing in

• Whether they are tracker or fixed
• Spread above the base rate (for trackers)
• Rate (for fixed rate)
• Length of "teaser period" and associated rate/spread
• Whether you can offset against savings or not
• Pre-payment options and fees
• Whether or not they are transferable to a new property
• Set-up fees

As well as this, assumptions about what interest rates will do in the future are important (if you think rates will rise it could be better to fix at a lower rate). Your own tax and savings situation also factors in - if you pay a high rate of tax on interest income, it may be better to offset your mortgage interest rather than earn interest in a bank account, but this tax advantage is not present if you do not pay a high rate of tax, or if you do not have a lot of savings.

Most mortgage comparison sites work by comparing either initial monthly payments or APRs, assuming (a) that interest rates will not change and (b) that you will not offset any of your mortage. They also don't generally take your individual tax or savings situation into account.

I could build a complicated simulator which allows for different interest rate outcomes, offsetting plans, tax rates etc but it feels like something like this should already exist. How should a layperson deal with this complexity?

Answer 1

I don't know about how a layperson "should" deal with it, but I dealt with it by creating a giant spreadsheet of doom where I could compare different options based on the two main factors I felt were worth simulating:

1. interest rate rises (which I can't control, but definitely must include in my forecasting)
2. overpayments and offsetting (which I can control to some extent)

Take the basic fees and interest rate for each product you are interested in, and plug in over a 5 year period what you end up paying (and still owing) in the different scenarios for interest rates and overpayments/offsets.

In my experience you then end up with a "X is better than Y if base rates go above 5%" type of comparison and you can then decide how likely it is that that scenario will occur in reality. If "X" and "Y" end up with similar numbers for the scenario(s) you think are most likely, then you can compare other aspects like ease of transfer to another property, etc.

I strongly suspect that most laypeople deal with this by picking whatever looks the most attractive from a relatively simple perspective (probably a combination of APR and set up fees), like the comparison sites do, or by doing whatever the mortgage advisor in their bank tells them is the best option. Most laypeople don't have the skills or desire to get involved in the level of complexity you describe.

Answer 2

Mostly by ignoring the complexity and just picking a mortgage that has the features they want, given their personal circumstances.

To elaborate a bit. You can create a spreadsheet, and fill it with finger-in-the-air guesses as to what will happen to interest rates, your income, your other personal circumstances, and so on. But it's hard to factor in options such as the ability to make over-payments without penalty. In the end, you could tweak the guesses to produce almost any result you want.

So, more likely, you'd pick a mortgage that has features you care about, ignoring ones you don't. Then look for the low interest rates, combined with the low fees. When balancing fees against interest rates, consider only the initial fixed rate/reduced rate/whatever period. After that period, you'll go on to their over-priced standard variable rate. At that point you should be looking around for another mortgage deal anyway.