When it comes to getting a mortgage, those looking for the cheapest rates and best deals usually end up with one of the big six banks or a major building society.
But in recent weeks, some of the best rates on offer have been coming from lesser-known sources.
They are being offered by small, local building societies – the likes of which the average borrower might not even have heard of.
Outside the box: Mortgage borrowers opting for smaller, regional lenders instead of high-street names are being rewarded with better rates
For someone wanting to buy a £200,000 home with a 25 per cent deposit today – according to This is Money and L&C’s mortgage finder tool – the best two-year fix for overall cost – excluding cashback mortgages – is with The Cambridge Building Society, which is offering a 2.54 per cent rate with a £199 fee.
On a five-year basis, The Cambridge offers the best deal at 2.69 per cent with a £199 fee.
And according to its website, Hanley Economic Building Society – which has only seven branches, all in Staffordshire – has a five-deal for those with 25 per cent deposits at a very low 1.99 per cent with an £849 fee.
For an 80 per cent deposit, Loughborough Building Society is offering a best-buy three-year fix at 2.39 per cent with a £499 fee. Also a small operation, the Leicestershire and Derbyshire-based mutual has only four branches and around 55 members of staff.
Someone looking to buy with a 40 per cent deposit would see that the two lowest rates were from Family Building Society, based in Epsom, Surrey at 2.44 per cent and Ipswich Building Society at 2.45 per cent – though they both come with circa £1,350 in fees, meaning they don’t offer the best deal overall.
The rates are tantalising, but there are several things borrowers need to consider before jumping out of bed with a big bank and in with a niche mutual.
So, what do borrowers need to know when considering a smaller lender for their mortgage or remortgage?
Small but mighty: The Loughborough is offering a best-buy three-year fixed mortgage at 2.39 per cent with a £499 fee, for those with a 25 per cent deposit
Why are small mutuals offering cheap rates?
Local building societies generally have slightly more expensive mortgage interest rates than the big high street banks – but that has changed recently.
There are two reasons for this. First, some say the big banks are deliberately setting some of their rates above those of other lenders, in order to reduce the number of customers they get.
This might sound counter-intuitive, but large lenders have seen a massive surge in mortgage applications in the last two years; first because of the home-moving boom during the pandemic, and now because people are rushing to remortgage in order to shield themselves against rising interest rates.
Both have meant that their staff are working through a huge backlog of applications, spelling delays for customers.
Scott Taylor-Barr, financial adviser at Carl Summers Financial Services, says: ‘To protect service levels and allow their teams time to cope with the applications, they already have, they have increased rates to effectively take themselves out of the market.’
Secondly, the way regional building societies get the money they lend out to customers as mortgages is different to big banks.
To fund balance sheets to allow mortgage lending, money usually comes from one of two places: deposits in savings accounts, or money that the bank has borrowed in more complex ways on the financial markets.
Smaller building societies tend to rely more on the former and big banks the latter – and this gives the building societies an advantage when interest rates are rising and it costs more for banks to borrow money.
But while small lenders are offering best buys for now, the margins are fine and brokers are already warning that these cheap building society deals may not be around for long.
Nicholas Mendes, mortgage technical manager at broker John Charcol, said: ‘It is important to note that these deals will not be around forever.
‘Building societies are not set up to deal with the same number of applications as high street lenders, and this is mainly down to resources. As such once they have reached their capacity deals will quickly be withdrawn.’
What if I have a smaller deposit?
There are good deals for those with smaller deposits, too.
According to the financial information service Defaqto, the best two and five-year fixed rates available for first-time buyers with a 15 per cent deposit are both from Cumberland Building Society, based in Cumbria – at 2.73 per cent with no fee and 2.59 per cent with a £999 fee respectively.
Cambridge Building Society offers the best two-year fix with a 10 per cent deposit at 2.69 per cent with no fee.
The Cumberland, headquartered in Carlisle, Cumbria, is also offering competitive rates
What are the pros of using a small lender?
Other than the competitive interest rates they are offering, there are plenty of reasons why small, local building societies can be a good place to head in search of a mortgage – though they are not for everyone, as we explain below.
Building societies are owned by their members, so they don’t have to meet the demands of shareholders like banks.
They generally don’t get a negative a reception from the public as banks, and because they have fewer customers their service is often said to be better and less impersonal.
Less rigid criteria
Large banks – and some big building societies – use an automatic computer system to make an initial decision about whether they will approve a mortgage application – though the customer’s credit score and other information are later checked over by a human.
This means it can be harder for those with unusual circumstances, for example self-employed people, those buying an unconventional property or those with blips in their credit history, to get approved.
Opening the door: Small lenders are sometimes more flexible with their lending criteria, which could help those with unusual circumstances or imperfect financial records get on the ladder
But smaller building societies usually use what is called ‘manual underwriting’.
This means a staff member will review the application without using automated checks. They have the discretion to accept applications that don’t exactly fit their criteria, and take into account mitigating factors – though they do work within certain lending and loan-to-value limits.
Smaller lenders don’t usually look at a credit score, although they do still assess the borrower’s financial history.
Jonathan Burridge, founder adviser at We Are Money, says: ‘Building societies are fundamentally different to banks and are there for their members and to help people own homes.
‘As such, you can find a more personal approach and often they are more willing to consider something where the “computer says no”‘.
With their flexible attitude and no big corporate structure, local building societies can also come up with some inventive – and useful – mortgage products.
These can be especially helpful for those getting on to the property ladder for the first time. For example, while most lenders will still give mortgages to those who live outside the area, some offer special rates or lower deposit requirements to borrowers who are local.
And Bath Building Society has a specific ‘rent a room’ mortgage where a borrower can use the income they plan to get from renting out a spare room as part of their income on the mortgage application.
There are also building societies to serve specific groups, such as the Teachers Building Society.
What to watch out for with a smaller lender
Slow application process
As well as more time-consuming manual underwriting, small building societies have less staff which can also drag the process out – so don’t expect an especially quick decision.
Burridge says: ‘Smaller lenders do not have the capacity of the big players so they often deliberately price to avoid being in the spotlight as they can be quickly drowned under a flood of applications.
‘So, if you are looking to grab a good rate prepared for a wait and possibly some frustration along the way.
‘Be kind if the experience is a little lumpy, once the deal completes you can brag about it to your friends.’
Online only: Those taking out a loan with a regional mutual that is outside of their area may have to be content carrying out their application over the internet or on the phone
At a time when rates are changing fast, however, borrowers could risk what Adrian Anderson of property finance specialist Anderson Harris calls a ‘slow “no”‘.
‘In a market where rates are rising, a transaction that takes five weeks to decline could cost you considerably as going back to the market for a fresh option is likely to lead to a considerably higher rate,’ he says.
There might be restrictions
In the past, most regional building societies would only lend mortgages – or open savings accounts – for people in their local area, but that is no broadly no longer the case.
Taylor-Barr says: ‘Happily all but the smallest building societies have done away with this practice now, but you may find they have special deals for more local borrowers.’
Borrowers will find that some building societies still have restrictions in place, however.
For example, some will restrict first-time buyer mortgages to borrowers from certain postcodes in their area.
Regional operators might also lend less to those buying in London and the South East, as such large loans are outside of their usual risk profile.
You won’t be able to visit a branch
If you prefer to drop in to a branch and do your mortgage application in person, opting for a regional building society hundreds of miles away will be impractical for obvious reasons.
Katie Brain of Defaqto says: ‘One of the downsides may be if you want to be able to drop in any paperwork or see an adviser in the branch, then the smaller building societies may not have a branch near you – although most mortgage applications are more likely to be done online or with a broker now.’
Best mortgage rates and how to find them
Finding a mortgage can seem confusing due to the huge range of deals on offer.
This is Money has partnered with independent fee-free mortgage broker L&C, to help you find the right home loan.
Our mortgage calculator can let you filter deals to see which ones suit your home’s value and level of deposit.
You can also compare different mortgage fixed rate lengths, from two-year fixes, to five-year fixes and even ten-year fixes, with monthly and total costs shown.
Use the tool at the link below to compare the best deals, factoring in both fees and rates.
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