Midweek Money: Beware - penalties can shatter your dreams

In the latest of her series on choosing the right mortgage, Rachel Fixsen warns borrowers that the most attractive rates do not always make for the most attractive deals
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The Independent Culture
TAKE OUT a fixed-rate mortgage now and you could be paying less than 1 per cent in interest on your home loan. But what is the catch?

Whether you are borrowing to buy your first home or are remortgaging to save money, you are faced with the choice of fixed-rate, capped-rate or variable-rate deals.

With a fixed-rate mortgage, the rate of interest you pay is set for a pre-determined period, usually up to five years. In a climate of falling interest rates, the fixed rate is likely to be lower than the prevailing variable rate.

"The danger people face is that the fixed rate could become uncompetitive over that time," says Simon Hooper, of Bristol & West. So a capped-rate mortgage can be more attractive. A capped rate is also agreed for a set period, and puts a ceiling on the rate of interest you will have to pay. If during the period interest rates should fall below the capped rate, the borrower would pay at the lower of the two.

A variable-rate mortgage means you agree to pay interest at the mortgage lender's standard variable rate which generally shadows Bank of England short-term money market interest rates.

Fixed-rate mortgages provide a safe haven for some home buyers. Coping with rising interest rates can be a nightmare. In the two years from 1987 to 1989, average interest payments on a pounds 60,000 mortgage went up by more than pounds 200 a month.

"What it really hinges on is budget," says Patrick Bunton, of mortgage brokers London & Country Mortgages. "Don't try to double-guess the market. If the mortgage you're taking out is going to account for a large part of your disposable income, then you should fix the rate," he says. Birmingham Midshires offers a rate fixed at 6.49 per cent for 10 years, according to financial data provider MoneyFacts. The deal carries a fee of pounds 295 and stipulates that you must take out the lender's buildings and contents insurance. Fees for fixed- and capped-rate deals are common, but watch out for the other catches. And, most importantly, watch out for redemption penalties. This is where you have to pay the lender a large sum of money - often the equivalent of six months' interest - if you pay off any extra capital within a pre-set period. The Scarborough Building Society shines in best-buy tables with its fixed-rate deal. You pay 0.99 per cent for a year, but then you have to stick with that lender for a further five years or face hefty redemption penalties.

Whichever fixed- or capped-rate mortgage you go for, you can expect to be tied into the agreement while the period of protected interest rates lasts.

But many lenders go further, locking you in for years after the fixed or capped rate has expired. This could leave you at the mercy of their standard variable rate, however uncompetitive that may prove to be.

"You are almost always better off taking a deal where there is no overhang," says Mr Bunton. If you take out a three-year deal with no lock-in at the end, the lender then has a huge incentive to offer further competitive mortgage terms, he says.

Many people are caught unawares by redemption penalty clauses. While they would expect a discounted rate mortgage to carry an extended lock- in period because it involves an element of subsidy from the lender, they would not expect this to be the case with a straightforward fixed deal. But very low fixed rates are often, in fact, discounted fixed rates. So are some mortgages mislabelled?

Sue Anderson, of the Council of Mortgage Lenders, says no. But there is a need to make some consumers more aware of conditions before they sign up for a mortgage, she adds.

"If it's a fixed rate that seems cheaper than other fixed rates, then look at the overall package to see if there's a redemption charge," she says. Rory Hegarty, of the National Consumer Council, says that the mortgage market can be a minefield for would-be borrowers.

"It really is very important for consumers to look very carefully at exactly what they are signing up for," he says.

"If a deal that you are considering ties you in after the fixed period, then consider shopping around because you might just find a better deal."

There are advantages of going for a variable rate deal. It enables you to choose one of the new breed of flexible mortgages that calculate interest daily and allow overpayments and underpayments. And anyway, according to economists' forecasts, interest rates have peaked for now.

"We think rates are going nowhere until next February," says Geoffrey Dicks, the UK economist at Greenwich NatWest. And then the next move will be down, he predicts. By the end of 1999, he forecasts that Bank of England money market rates will have fallen to 6.5 per cent from 7.5 per cent at the moment.

London & Country Mortgages: 01225 40800; Bristol & West: 0117 9792222; Council of Mortgage Lenders: 0171 440 2255

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