It pays to get on the track

Variable-rate borrowers are anxious about recent base rate rises but Stephen Pritchard says there is a way out
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The Independent Online

Mortgage borrowing reached a 10-year high in March, according to the latest figures released by the Bank of England. The rise - of 1.2 per cent to £9.3bn - was the largest ever since records began in 1994.

Mortgage borrowing reached a 10-year high in March, according to the latest figures released by the Bank of England. The rise - of 1.2 per cent to £9.3bn - was the largest ever since records began in 1994.

Earlier this month the Bank of England's Monetary Policy Committee bowed to pressure to raise rates (pressure which came in part from no less a man than the Chancellor, Gordon Brown who said in public that he wanted rates to go up) and voted a 0.25 per cent rise to 4.25 per cent - the first one since February. For borrowers, base rate rises inevitably translate into more expensive mortgages - unless they have been fortunate to take out a fixed-rate loan - and the most recent rise may not be the whole story.

City forecasters expect base rates to go up further, perhaps reaching 5 or 5.5 per cent. Members of the committee have described the 5 to 5.5 per cent band as "neutral" to the economy, neither stimulating, nor depressing demand, making it an obvious target for policy makers. But such a rate could easily mean mortgages reaching 6.5 or even 7 per cent.

Evidence to support City thinking can be found by looking at the cost of five-year, fixed-rate mortgages. According to Ray Boulger, the senior technical manager at the mortgage broker Charcol, five-year fixed rates started to rise just as base rates reached their low last summer. Then, borrowers could have found a fixed-rate deal at 3.85 per cent. Today the cheapest five-year mortgages on the market cost 5.2 per cent.

Switching from a variable rate mortgage to a fixed rate is only likely to be worth a borrower's while if the borrower is very pessimistic about interest rates, or is already on an expensive mortgage as the standard variable rates of some lenders are above even fixed five-year rates.

The lack of capped-rate mortgages on the market also lends weight to the idea that rates will rise. When long-term rates are low, lenders can afford to offer capped rates. As rates rise, fewer lenders will run the risk of offering a cap, or will raise the cap to a level that looks expensive, when set against current lending rates.

Robert Guy, at brokers Timothy James & Partners, favours a 5.59 per cent capped rate with Abbey. This offers protection against a worst-case scenario rate rise, but the cap is higher than a borrower could have found last year.

The most attractive interest rates on offer at the moment are often through tracker mortgages. These follow base rates by a fixed margin.

"Tracker loans can offer some cushion against rising interest rates as they track an index, usually the Bank of England base rate," Guy says. "This will normally be below a lender's variable interest rate."

But although these trackers prevent lenders from exploiting rises with above-base-rate increases, they offer no protection against Bank of England rate movements.

For existing home owners, the cost of switching the mortgage also needs to be set against a possible interest rate rise. As Boulger points out, anyone moving house will have to pay arrangement fees - and possibly redemption penalties - in any case. But someone thinking about a remortgage should only switch if the total costs still make it worthwhile.

As a rule, fixed and capped rate mortgages attract higher fees than variable or tracker loans, with higher up-front administration charges and redemption penalties during the loan. But only fixed and tracker loans offer complete protection against future rate rises.

"At the moment, the best tracker loans are around base rate," Boulger says. "Comparing that to a five-year fixed rate, the tracker will start off lower and - if rates do go to 5.5 per cent - it will go close to the fixed rate.

"If you are prepared to accept the unlikely risk that rates will go over 5.5 per cent, fixed rates look expensive. It is certainly unlikely to be worth paying a penalty to opt out of a current mortgage, unless you really think rates will go to 6 or 7 per cent."

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