Britons balk at Brown's preference for long-term, fixed-rate mortgages

Long-term, fixed-rate mortgages you can exit any time became a more realistic prospect this week, but British borrowers are unlikely to want to give up their short-term mortgage bargains.

Long-term, fixed-rate mortgages you can exit any time became a more realistic prospect this week, but British borrowers are unlikely to want to give up their short-term mortgage bargains.

A group of European banks this week said they were in talks to set up a way of funding mortgages across Europe that would allow long-term mortgages free of penalties. This will cheer Gordon Brown, who is keen to establish long-term, fixed-rate mortgages in the belief that they will bring more stability to the housing market and greater security to borrowers. This will also ease entry to the euro, because it means UK homeowners will be less sensitive to volatile European interest rates.

The project, known as the European Mortgage Finance Agency Project (EMFAP), would find investors in the capital markets to finance mortgages at a cheaper rate than individual banks can manage. The US operates such a system, through the federally guaranteed agencies called Fannie Mae and Freddie Mac. The guarantee allows them to borrow very cheaply and offer mortgages penalty-free.

Many UK homeowners will remember, with pain, interest rates of 15 per cent or more in the late 1980s, when mortgage repayments soared. The recent Bank of England interest-rate rise roused fears that repayments will start to creep up, making 25-year rates more attractive. But the UK has a love affair with short-term rates and this week's proposals from EMFAP have so far failed to convince many.

Six out of 10 mortgages in the UK are on a variable rate, and mortgage lenders are so competitive they constantly cut rates to offer the cheapest short-term interest deal they can. With the Bank of England base rate at 3.75 per cent, short-term mortgage rates can be picked up at 3.35 per cent.

"EMFAP is an exciting concept, were it not for the proposed rates, which we think would be 6.5 to 7 per cent," David Bitner, of The MarketPlace, says. "It would simply be unappealing. UK borrowers are used to having a choice and competitively priced deals. It is difficult to see why they would suddenly want to switch to a higher-priced product even if it provides long-term protection. They need to find a way to price these products with more attractive rates."

But Rob Thomas, the project manager of EMFAP, says its plans would create mortgage rates at less than 6 per cent, which would be a bold step forward for 25-year deals.

Fixed-rate terms of two, three and five years are common in the UK, but there have already been forays in to 25-year fixed deals. Cheshire Building Society and Leeds & Holbeck Building Society offered 5.48 per cent and 5.39 per cent respectively.

But even at rates below 6 per cent, long-term mortgages that have not been popular and Leeds & Holbeck no longer offers its product. "We found the take-up was modest, and it seems borrowers are not yet ready to look at long term rates," Tony Burdin, of Leeds & Holbeck says. "We do think they are right for many, but they have to be priced right."

The long-term mortgages on offer so far have had high redemption charges, in exchange for the security of the rate. For example, cash in your 10-year fixed rate from Britannia and you will be charged 360 days' interest at the standard variable rate. This can amount to thousands of pounds.

So the hope of a penalty-free fixed rate deal you can exit any time may be the answer to making long-term mortgages more popular. The 25-year deals available are not completely inflexible. The Leeds & Holbeck, for example, could be redeemed after five years, then every two years after that, free. Mr Burdin thinks these breaks would satisfy customer demand for flexibility and allow lenders to keep rates down. "Offer a mortgage at a high rate and no one will be interested, regardless of whether they can leave penalty-free at any time," he says.

Ray Boulger, mortgage expert at the broker Charcol, thinks 25-year deals will never take off in the UK while short-term rates remain low. "You have to have real concerns there will be a complete change in the country's economic environment and interest rates are going to go up significantly," he says. He cannot see the US-style system being acceptable to any national government or to the European Union, because they would have to provide a subsidy to bring the rates down.

There are also concerns that long-term rates would lead to large arrangement fees. They do give peace of mind that repayments will not increase. And if the Chancellor is determined to make long-term rates more popular, he may consider tax breaks for those who choose them.

Interest rates seem to be on the up, which is bound to make long-term fixed rates more appealing. But the increase will be slow. Many people are more comfortable planning their borrowings on a time-scale of no more than five years ahead and are reluctant to lock themselves in for the long-term. Although EMFAP can offer greater choice and security, the proposals for long-term mortgages are not yet good enough to attract customers. Until this changes, short-term deals are still likely to win the day.

'Fixed rate has given us security'

Alison Davidson wanted the cheapest rate on the market. The office manager in Newport has taken out a two-year fixed-rate mortgage. Mrs Davidson, who has two children, went with her husband Andrew, a fitter, to The MarketPlace at Bradford & Bingley, and asked the independent advisers to shop for the best deal.

"I did want a fixed rate, because they give you security and ensure payments don't rise, and I would have liked to get a fixed-rate for longer than two years," she says.

"But the rates became much more expensive when you fixed for longer. When we got this deal for two years, we weren't prepared to make our monthly outgoings any higher."