Money: Don't fear the end of the quick fix

Many mortgage borrowers are coming to the end of fixed and discounted home loan rates. The sudden move to higher rates has prompted warnings of "payment shock" and even repossessions, as borrowers are forced to pay more for their loans. Nic Cicutti examin
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One of the major features of the mortgage market in the past three or four years has been the decision by hundreds of thousands of new and existing borrowers to take out fixed and discounted home loans.

For increasing numbers of people, including many who experienced the rapid increase in variable interest mortgage rates in the late 1980s and early 1990s, fixing has been the way to stabilise payments for several years at a time.

Fixing the cost of a loan, or getting a good discount to the then prevailing variable rate has paid dividends for many borrowers. The potential downside is the effect on their finances when the fixed or discounted period comes to and end. For many, that time is likely to come about in the next year or so.

However, new research from the Council of Mortgage Lenders (CML), which represents the lending industry, suggests that fears of meltdown as people suddenly discover their payments are about to rocket, have been overstated.

The CML's research indicates that about 13 per cent of all outstanding loans, or 19 per cent by value, are now on a fixed rate basis. One third of mortgages are based on the "annual review" system, whereby lenders alter payment rates only once every 12 months.

A further 21 per cent of loans, 21 per cent in value terms, are discounted - many having been taken out in the past year. Here, expectations of rises and subsequent falls in interest rates, have meant that up to 44 per cent of loans taken out in the 12 months to June have been discounted.

Writing in the latest issue of CML News, Fionnuala Earley, the organisation's senior economist, suggests that among the fixed rates, about half are expected to mature in the coming year. A further quarter will mature in one to two years, with the remainder coming to an end between two and five years from today.

A similarly short profile exists for those on discounted rates: some 60 per cent of loans advanced in the year to June were for between two and five years, with most skewed to the bottom end of that time period.

"The fact that the UK economy is currently in a period of rising interest rates could lead to an expectation that payment shock for those coming out of fixed rate periods might be more severe that, say, a year ago - particularly as the proportion of fixed rates maturing over the next year is so high," Ms Earley says.

"Combined with the reduction of mortgage interest tax relief [Miras] and the scaled back Income Support for unemployed home owners, there might be an effect on default rates. However, a closer examination of the likely effects reveals a less worrying outlook."

Using statistics culled from the Halifax, Ms Earley points out that borrowers coming on to a standard variable rate in January 1997 at the end of a three-year fixed rate loan of 6.95 per cent, as was available in March 1997, would have seen the cost of their mortgage rise to 7.20 per cent on average, an overall increase of 0.27 per cent.

Even in January 1994, when the cost of a three-year fix was a more economical 6.49 per cent, the increase would have been manageable, at 0.71 per cent.

By April 1994, when fixed rates were rising and a typical three-year deal cost 7.49 per cent, coming out would actually have led to a minor saving.

A four-year deal, maturing next year, would have cost 7.95 per cent in April 1994. When borrowers are forced back on to variable rates next year, the likely prevailing cost of the loan will be 8.7 per cent from most lenders. This means an increase of about pounds 28 a month on a typical pounds 50,000 loan.

Of course, not all deals were quite so dear in 1994: as this author can vouch, some three and four-year fixed offers were available at up to 6.45 per cent even then, albeit with compulsory insurance being required.

But the inference is clear. Ms Earley adds: "Looking at the product maturing early next year, the likely impact will be a jump in rates of about 0.75 per cent.

"However, given the increase in average earnings over that period and also taking into account that lending criteria provide for the possibility of increases in mortgage rates, there is unlikely to be a large impact on the market resulting from mortgage shock."

She adds that re-mortgaging at the end of fixed-rate mortgage periods, now that increasing numbers of lenders are offering redemption-free mortgages, may become more common over the next few years.

Ms Earley says: "It should not be forgotten that in the meantime, borrowers have had the benefit of not seeing their payments increase, giving them time to plan for the increase. In future, there is no reason to believe that the effect of increased payments at the end of fixed rate periods may not be so severe.

"If short term rates in five years time are in line with expectations, there should be very little payment shock for borrowers taking out fixed rate finance now, when the period terminates in three to five years' time. In a low inflation world, interest rates should be more stable and consequently the size of any shock should be minimal."

Where does all this clever research leave the poor borrower facing the end of a comfortable fix or discount in the next few months? There are two main points to note: the first is that they are unlikely to be penalised as heavily as they may have thought. The second is that lenders are canny creatures. By and large, despite every effort by borrowers in search of a bargain to gamble on rates two or three years' hence, the deals are remarkably close to where lenders expected them to be when they were first offered.

The moral of the story, if there is one, is that fixed and discounted mortgages are there primarily to offer stability to loan repayments over a set number of years. Anything else is best left to the experts - and even they may get it wrong.

The Independent's free 27-page 'Guide to Mortgages', written by Nic Cicutti, the paper's personal finance editor, and sponsored by Barclays Mortgages, is available to all readers by calling 0800 585691. Or fill in the coupon on page 19.