Don't let oil send your mortgage costs spiralling

With more base rate rises likely, you may be better off with a different mortgage
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The Independent Online

Within hours of Britain's biggest mortgage lenders announcing their intention to pass on last week's rise in the Bank of England's base rate, Governor Mervyn King issued a stark warning on Wednesday. He said there was a "50:50" chance the Bank would miss its inflation targets in the next six months, triggering further interest rate rises.

The most serious inflationary threat is the rise in oil prices - pushed to a new high this week by tension in the Middle East - but factors such as higher university fees are also contributing to the problem

The pressure is therefore on to cut your mortgage costs with a better home-loan deal. At first sight, cut-price variable rates now look better value than fixed-rate mortgages. The best two-year fixes currently available - such as the 4.69 and 4.79 per cent offers from, respectively Portman and Skipton building societies - are markedly more expensive. Bristol & West offers two-year discounted variable rate deals for less than 4.5 per cent, while Direct Line's two-year tracker deal is at 4.44 per cent.

However, the choice between a variable or fixed-rate mortgage should not first and foremost depend on the cost of the two options. David Hollingworth, of mortgage adviser London & Country, says: "For anyone with any doubts about their ability to stay on top of mortgage repayments should rates rise further, a fixed-rate deal makes sense."

On a typical £100,000 mortgage, each 0.25 percentage point increase in the interest rate paid adds around £16 to a borrower's monthly repayment. The worst case scenario is there could be two or three more rate rises over the next 18 months. That would mean a total extra monthly repayment of more than £60 on the average home loan.

Hollingworth advises anyone prepared to pay the premium required for certainty about future payments to fix as soon as possible. The professional money markets, which lenders use to finance fixed-rate offers, are expecting at least one more base-rate rise and the cost of money is already higher. That means the cheapest fixed rates will not remain on offer for long.

Another quirk of finance on the money markets, adds Melanie Bien, of Savills Private Finance, is that cash for longer-term fixed rates - up to 10 years - is cheaper. "With the prevailing trend in long-term fixes downwards, it might be worth opting for a longer fix," Bien says.

Woolwich, for example, this week launched a 10-year deal priced at 4.98 per cent a year. The risk of tying yourself in for so long - redemption penalties are payable if you get out early - is that your options will be limited if you want to move house and need to borrow more money. You'll then have to depend on Woolwich being prepared to lend you more, at a decent rate.

For borrowers who aren't concerned about the risk of rising repayments, the choice between fixed and variable-rate deals remains finely balanced. "If you believe the base rate is going to go up to 5.25 per cent or more you can make a very good case for fixing," says Ray Boulger, of mortgage adviser Charcol. "I expect base rates to remain at 4.75 per cent for the rest of the year and on that basis a fix is not likely to work out cheaper, but I could be wrong."

If not, borrowers choosing variable rates need to be careful. Some lenders will use the base-rate hike as an opportunity to widen their profit margins. The One Account, for example, has already raised its mortgage rates by 0.3 per cent, more than the base rate increase.

The only sure way to avoid being caught out in this way is with a tracker mortgage, where the rate you pay is guaranteed to move up and down exactly in line with base rates. However, the cheapest variable-rate deals currently are not trackers, so borrowers could lose out in future if lenders don't play fair. It's a question of deciding whether the saving available today justifies taking that risk.

Finally, there is a compromise option. Coventry Building Society offers a three-year capped-rate: borrowers are guaranteed to pay no more than 5.25 per cent, whatever happens to base rates.

The underlying cost of the deal is base rate plus 0.75 per cent, so borrowers' repayments would drop if and when rates fall below 4.5 per cent. The deal offers certainty about the size of your repayments, plus a chance of benefiting from future base rate cuts.

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