How to be a winner in the home loans war

In the increasingly fierce war to provide home loans, an eye for a bargain can help slash hundreds of pounds off the cost of your mortgage. Nic Cicutti looks at the background to the battle, spells out what it means for you and highlights the most attractive deals on offer
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The Independent Online
A smell of cordite is wafting across the mortgage battlefield, as lenders fire fresh broadsides in the increasingly fierce war to provide cheap home loans to their borrowers. Uppermost in their minds is the question of whether they can slash their rates enough to win homebuyers into their camp. There is a second imperative for lenders, that of how to prevent their own camp-followers from deserting to the other side. For millions of borrowers, the question is different: if there is a mortgage war going on, how can they win it? What spoils can they gain out of it?

Make no mistake about it, there is a war taking place. The victors are those lenders able to snaffle away customers from under the noses of their rivals while losing the least numbers in return.

For you, it means a careful assessment of your individual position; an eye for a bargain can help slash hundreds of pounds off the annual cost of your mortgage.

The first thing to understand is why mortgage lenders have been forced into a war. There are several factors to consider. Probably the most significant is the state of the housing market. House prices have collapsed in many areas and are up to 25 per cent lower than in the heady days of the late 1980s.

This week's detailed survey from Nationwide highlighted the scale of the problem. The building society released figures showing that 1.7 million borrowers - one in seven of all homebuyers - are in negative equity, where their mortgages are greater than the value of the property. Equally worrying is the fact that for one million more borrowers the equity in their property - the margin between the mortgage and the value of the house - is less than pounds 3,500. If you fall into this category, and want to move, you can't do so without going into the red.

This block on people's ability to purchase another home, affecting one in four of all mortgage-holders, is also a tremendous obstacle for lenders trying to persuade fresh generations of homebuyers into the market. Think about it. You save a few thousand pounds over the years. The money earns you a tidy, though not particularly generous, amount of interest in a building society account.

Then someone comes to you and offers to lend you money to buy a pile of bricks that will only fall in value over the years. What is more, you must also assign the amount you have saved up to the same pile. Does this seem a good deal to you?

Hardly surprisingly, the house- buying enthusiasm of people in their early 20s has gone into dramatic reverse in the past five years. Everyone knows a horror story about a friend, or a friend of a friend, who bought in 1988 or 1989 and handed in their house keys a few years later. Although lenders say that things are getting better, 1,000 people a week are still having their homes repossessed. Many tens of thousands are in heavy arrears, with no hope of paying their loans off.

In the 1980s, mortgage lenders, primarily building societies, hardly had to worry where their next punter came from. All of them were able to lend as much as they chose to. Some did so with a vengeance and paid the price. Nowadays, things are not looking so good for them. Far from people beating a path to their door, they are staying away. In fact, last year new house purchases fell to a low not seen since the first price collapse in 1990-91.

An additional side-effect of the prevailing uncertainty in many people's minds is that they are not so keen to speculate in the wide range of unit trusts and other investments so popular until just a year or two ago. The result has been a flood of money pouring into building society coffers, money which societies are desperate to lend again. If only there were some takers.

What is a lender to do? The answer is to behave as any other business does. If price is seen as one of the obstacles preventing people from buying, you cut that price. For most lenders it means cutting the cost of a home loan. Their strategy has been helped by the Kenneth Clarke, the Chancellor of the Exchequer. In the past few months, he has twice reduced base rates by a total of 0.5 per cent. In turn, this has allowed lenders to cut the cost of their loans. What is significant is that they have not only matched Mr Clarke pound for pound but have slashed their mortgage rates by up to 1 per cent since September. The effect of this for existing mortgage borrowers has been to cut the cost of an average pounds 50,000 loan fall by up to pounds 40 a month.

That's not all. De-mutualisation fever has gripped millions of members of the top 10 building societies. Most of them stand to gain from the pounds 15bn share or cash bonanza being handed out, as one society after another prepares to float on the stock market.

For those societies still wedded to the concept of mutuality, or too small to seek bank status, the solution is to offer their members the benefits that mutuality is supposed to bring. This means cheaper mortgages and better savings rates as "loyalty bonuses" - basically keeping their members sweet by forgoing a slice of their profits. In the case of Bradford & Bingley, it is handing back pounds 50m to its members a year by cutting 0.25 per cent off its variable rate to 7.24 per cent. Yorkshire Building Society is handing back pounds 20m. Its own rate now stands at a reasonably competitive 7.39 per cent. It could be argued that they should have done so sooner. Even so, the fact that they are moving at last is good news for their members.

The consequence of such bonuses, soon to be announced by Nationwide, Britannia, Skipton and just about everyone else, has opened an intriguing and highly significant new front in the mortgage war. By handing their profits back to savers and borrowers, building societies are in effect challenging the "neo-banks" to follow. They will almost certainly have to if they are to remain competitive. But for a public company to do so means cutting into its profits and its shareholders' dividends. Hence the squeals of anguish from existing shareholders, who are dumping their holdings in Abbey National and other banks. A war always has some unexpected casualties.

There is a final factor to bear in mind - mortgages by telephone. In the past two years, a number of lenders have set up telephone lending operations. By cutting out their expensive branch networks, they can offer the attraction of cheap mortgages.Some of these operations are bogus. If you call, you will be directed back to the society's local branch, or the mortgage rate you are offered is no different from that already available in the high street.

But in the past week both Bradford & Bingley and Direct Line, the staggeringly successful telephone insurance operation, have opened hostilities on a new mortgage salient. Direct Line started it by dropping its variable rate to 6.49 per cent. B&B replied within hours, reducing its own rate to 6.25 per cent, the cheapest now available.

Another new telephone lender, FirstMortgage, operates slightly differently. It offers a far wider choice of loans, ranging from fixed to discounted rates. It also guarantees that after the fixed period ends - in two or three years' time - it will place borrowers on to a rate which is one- quarter per cent lower than the average of that available from the top five building societies.

At present, all of these players are minnows. Their combined lending last year totalled barely pounds 1bn, compared with the billions lent by conventional societies. But just as telephone insurance was derided 10 years ago and now dominates the market for motor and household cover, telephone mortgages are likely to become a key force by the end of the decade.

All these competitive forces are good news for borrowers. They mean that in their desperation to attract new business, lenders are also offering a plethora of special deals.

So what kind of loan should you go for? The answer is that there is no single best mortgage that will suit everyone. It depends on your needs and where you see the market going in the next two years or so, the furthest it is really safe to predict rates for.

The arguments above point to one conclusion, which is that mortgages are likely to remain at their current low levels or to fall further over the coming year. The experts believe that in a low-inflation climate, and with the economy slowing down, the pressure will be on Kenneth Clarke to keep base rates as low as he can. This means that mortgages will also stay low.

Of course, all such predictions must be taken with a pinch of salt. Barely 15 months ago, these same experts were confidently predicting that interest rates were set to rise up to 9 per cent or more. The consequence of that prediction was that it was virtually impossible a year ago to fix your mortgage for five years at a rate of less than 8.5 per cent.

Let's assume that this time they are right, at least for the next year or so. In that case, it makes sense for you to opt for a discounted mortgage. This is where a lender cuts several percentage points off the variable rate and promises to keep that discount for, say, two or three years. If the variable rate falls, the cost of your loan drops by the same amount. A two-year gamble on falling rates makes eminent sense in such circumstances.

MoneyFacts, which charts all the mortgage deals available on the market, singles out Northern Rock, for its discount of 6.25 per cent off its variable rate until May 1997. You pay just 1.19 per cent over that period. Thereafter you move onto the society's variable rate, currently 7.44 per cent. For that you must take out Northern Rock's own home and contents insurance policies.

First-time buyers, who traditionally face difficulties with the cost of decorating and furnishing their properties, may be attracted by another deal from Britannia Building Society. This offers a 2.75 per cent discount in the first year, giving an actual mortgage rate of 4.74 per cent. However, the society also rebates back 3 per cent of the sum borrowed, up to pounds 6,000, provides free unemployment insurance for one year and refunds the valuation fee, up to pounds 400.

Alternatively, FirstMortgage has a three-year deal, giving a discount of 2.25 per cent on a variable rate of 7.49 per cent. Over two years, the discount mounts to 3.25 per cent.

Discounts may not suit everyone - especially those who prefer to know exactly how much they must pay each month rather than cope with changing repayments. Coventry Building Society this week offered a fixed rate of 3.9 per cent over two years. Over four years, the rate is 6.7 per cent. Five-year fixes are priced at 6.79 per cent, which is probably the cheapest now available.

One crucial fact to remember is that when you take out a fixed or discounted loan it is usually impossible to walk away from it. If rates were to fall, or rise, you are tied to that mortgage by means of hefty redemption penalties of as much as six months' interest. If you opt for a fixed or discounted deal, you will incur penalties for several years after switching back to the variable rate.

That may not matter. After all, if you are re-mortgaging the chances are that you were on the variable rate anyway. But it may also mean that if more tasty deals come up in a year's time, you will be excluded from applying. The consequence of such a decision can be expensive. There are still cases of borrowers who, frightened by rates at 14 per cent plus in the early 1990s, opted for five-year deals at 12 per cent. They have paid heavily for their decision. Coventry does not apply redemption penalties at present. Nor does FirstMortgage, on some of its mortgage products.

The key point to remember is that if the only reason you choose a discount or a mortgage is because you want to gamble on rates, the chances are 50-50 that you will be wrong.

Try thinking of it as a budget planning exercise: pick a rate so that you know how much your repayments will be a few years hence rather than taking a punt on the money markets.

There are two final questions to which any prospective homeowner wants the answer. Is this the right time to buy? And if you buy a house, what guarantee is there that its value won't have plummeted over the next decade? There isn't one. House prices are at their lowest for many years, making them a bargain compared to the late 1980s. Mortgages are also low.

Despite the experts' confident predictions, however - which take in pent- up demand, the shortage of good house-building land, growing numbers of single-parent families and all the rest - the fact is that there is simply no way of knowing whether the current aversion to home purchase is a permanent phenomenon or if it is working its way out. Remember, the experts have all been wrong before.

If you buy a home, it must be because you want a particular type of roof over your head rather than the rented accommodation you are in. In that context, house price rises or falls are immaterial.If you do decide to buy, take care and shop around carefully. You are likely to end up a winner in the war rather than just another casualty.

Case study The Rutledge family

Tony and Judy Rutledge bought their house on the Isle of Wight five years ago with a mortgage from Nationwide - but a friendly local insurance broker suggested last month that they should remortgage with Northern Rock and take advantage of a rebate of 6 per cent of the outstanding mortgage, worth in their case more than pounds 2,500.

There would be no survey fee, and the solicitor's fee of pounds 300 to transfer the mortgage and the arrangement fee of pounds 295 could be deducted from the cashback, leaving them with pounds 2,000 clear.

On the basis that nothing is for nothing, Tony asked a few questions, but the offer seems genuine enough and compares well with others currently available.

They will have to repay the cashback if they want to change lenders again within six years and they will be paying Northern Rock's variable mortgage rate, currently 7.44 per cent. This is not the cheapest available - for example, Bradford & Bingley's is 6.25 per cent - but the cashback is just as good value and it is upfront.

They could have chosen a 6.25 per cent discount on the interest rate for a year instead of the 6 per cent cashback, but that would reduce the MIRAS tax-relief as well as the interest bill. The Inland Revenue toyed last year with the idea of taxing cashbacks but has now accepted that they are not liable to tax.

Northern Rock's buildings and contents insurance may not be the best value, but it is not compulsory - and there is a 0.25 per cent discount on the mortgage rate if they do take it.

TEN THINGS YOU NEED TO KNOW ABOUT MORTGAGES

1. You don't have to buy a property or move house to get a mortgage bargain. You simply remortgage and repay your old loan.

2. The best bargain offers will usually lend borrowers only 75 per cent or less ofvaluation - that's the value their surveyor puts on your property.

3. Some lenders, especially the telephone-based ones, offer loans at standard variable rates below the general market rate.

4. Special offers give a choice between a fixed rate, a discount on the normal mortgage rate for a set period, or a cash rebate, usually a percentage of your loan.

5. A fixed-rate mortgage commits you whether variable rates rise or fall.

6. If you accept a special offer you will be penalised if you want to move lenders again within a specific time.

7 The penalty period could well be longer than the cheap rate lasts.

8. Remortgages usually involve other costs, survey fees, solicitor's fees, search fees, and compulsory house and contents insurance.

9. If you repay an old loan early it usually pays to do so at the end of a month, not the start.

10.Negative equity disqualifies you from most if not all special offers.

THE KEY PLAYERS AND THE DEALS THEY OFFER

Alliance & Leicester: New fixed rates this week include 1.95% for 1 year, 4.99 for 2 years, 6.70% for 3 years, max loan 95%.

Bradford & Bingley Direct: The standard variable rate is cut by 0.25% to 7.24% for new and existing borrowers.

Britannia: First time buyer rate 4.74% for a year, max loan 95%; 3% loan rebate, free unemployment insurance, no valuation fee.

Coventry Building Society: new fixed rates of 4.71% for 2 years, maximum loan 85%, and 4.97% for a 95% loan, with pounds 400 cash rebate.

Direct Line:standard variable rate is reduced by 0.21% to 6.49%, for both new and existing borrowers.

Halifax Building Society: 1.44% mortgage available (6% discount) to 30/4/97, maximum loan 90%; 4.99% deal (2.5% discount) to 30/4/99.

Northern Rock: fixed rates 4.24% for 2 years, 6.24% for 3 years; an extra 0.25% off with the Society's buildings and contents insurance.

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