Capped-rate deals are in fashion but will they wear well?
Sunday 26 March 2006
Fashions come and go, even in the mortgage market, and now one is coming back. This spring sees the re-emergence on the catwalk of the capped loan, a deal that moves in line with interest rates but promises not to rise above a certain ceiling.
For the first time since 2002, the Woolwich last week reinstated a capped deal in its mortgage range, while the Coventry building society has also unveiled a new capped rate.
Greater uncertainty among borrowers over the direction of the cost of borrowing lies behind the fresh demand, says Andy Gray, head of mortgages at the Woolwich. "We had all expected cuts in the base rate this year but the housing market has been strong and [rates] haven't fallen as predicted.
"In light of this, homeowners are reluctant to fix [in case rates do go lower], but they also want security of payment should borrowing costs rise."
Capped rates were particularly popular when, between January and December 2001, the Bank of England base rate fell by two percentage points to 4 per cent. In this situation, homeowners wanted the best of both worlds: to reap the benefits of the cuts but also to be able to budget for a maximum monthly repayment if rates rose again.
However, with the cost of borrowing stabilising, cheaper fixed and discounted variable-rate mortgages have since become more popular. As a result, lenders have generally dropped capped deals from their product ranges.
Now, with the outlook more uncertain, they're starting to come back into vogue. But that doesn't mean borrowers should rush to snap one up, warns Ray Boulger at mortgage broker John Charcol, as capped-rate deals rarely give the best value.
"Many are linked to lenders' standard variable rates [SVRs], and these have to fall dramatically for borrowers to pay less than the rate of the cap."
The new three-year Woolwich deal, on offer at 4.89 per cent, is a prime example. For customers to pay less each month, the lender's SVR - 6.59 per cent in the case of the Woolwich - would have to drop below 4.89. And the chance of that happening in the next three years looks remote. First, the Bank of England base rate - currently 4.5 per cent - would probably have to fall by around 1.75 percentage points. Second, lenders aren't obliged to mirror base-rate cuts in their own SVRs. So borrowers could be left without the benefits.
In this case, customers might as well regard the mortgage as a three-year fixed rate. And that could be a decent option as the Woolwich's own three-year fix is priced at 4.99 per cent.
But there are better deals elsewhere: the Portman and Newcastle building societies offer three-year fixes at 4.54 per cent.
"If you're looking for some certainty of payments, a competitive fix is likely to be the best option," says Melanie Bien of broker Savills Private Finance. "And if you're worried rates may fall, you could opt for a shorter fix rather than a longer one."
Not all capped rates are linked to a lender's SVR. Coventry's deal stipulates that you pay 0.75 percentage points above base rate - capped at 4.99 per cent. That's a good offer at the moment as your repayments would otherwise be at 5.25 per cent.
If you have a 25 per cent deposit, Leeds building society offers a three-year cap that tracks base rate plus 0.25 per cent. Its current rate, 4.75 per cent, is also the cap; if the next move by the Bank is downwards, borrowers will see an immediate benefit.
But brokers largely agree that fixes and deeply discounted base-rate trackers offer the best value.
Civil servant Penny Dean, about to complete on a £156,000 two-bed flat in Brighton, dallied with a capped deal but chose Coventry's four-year fix at 4.99 per cent. "The cap came with tie-ins and was priced slightly higher," she explains.
"I've had a capped deal before, though, and would do so again if my circumstances were right."
Independent Partners: Get fee-free expert mortgage advice and find the right mortgage deal for you.
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