Lender squeeze makes tracker deals appear more attractive
But a mortgage that follows the base rate has its own risks, write Chiara Cavaglieri and Julian Knight
Sunday 10 January 2010
The new decade isn't even a fortnight old, yet borrowers are feeling the squeeze again.
This time, it's lenders looking to repair their balance sheets by raising the cost of standard variable rate (SVR) mortgages. Marsden Building Society customers have to contend with a new SVR of 5.95 per cent, up from 5.49 per cent, and from tomorrow, Mansfield, another building society, will raise its SVR for existing borrowers from 5.24 per cent to 5.59 per cent. Even without the changes, plenty of high SVRs are on offer, such as the 6.45 per cent levied by the Chesham Building Society.
And it's not going to stop there. David Hollingworth of broker London and Country says: "This is part of a growing trend with SVRs. For once, it's not greed. Building societies in particular are finding it hard in an increasingly competitive savings market. In order to subsidise the rates they have to offer to attract savers, they are raising the costs from their SVR mortgage customers."
So what should borrowers do? One option, says Mr Hollingworth, is to go for a tracker mortgage, which, as the name suggests, follows moves in the Bank of England base rate, currently at a historically low 0.5 per cent. "The beauty about trackers is that it takes the decision on rates out of the hands of the lender. No matter how much they are having to pay to attract savings, it doesn't affect tracker-mortgage holders."
Tracker mortgages are offered at a set margin above or below the base rate, rather than being linked to the lender's SVR like a discounted deal. This can be for a specific period, such as two years, or can last for the entire term of the loan, as with a lifetime tracker mortgage. For example, the lifetime tracker from First Direct tracks base plus 2.18 per cent, with a fee of £999. Currently at 2.68 per cent, this mortgage is highly competitive in comparison to other fixed-rate deals and SVRs on the market. Even First Direct's own two-year fixed rate, which is top of the best-buy table, has a rate of 3.64 per cent, plus a fee of £498 for borrowers with a loan-to-value ratio (LTV) of 65 per cent.
As things stand, the argument for lifetime trackers is strong. According to financial comparison site Moneyfacts.co.uk, the average lifetime tracker rate stands at 3.72 per cent, while the average SVR is 4.68 per cent, and the average five-year fixed rate is 6.09 per cent. Over a 25-year term, therefore, a £150,000 tracker mortgage would currently cost £768.75 per month, and over the term of the loan it would amount to £230,625. In contrast, the average SVR would cost £849.15 per month and £254,745 for the term. Rates below 3.72 per cent are available. Legal & General launched a lifetime tracker last week set at 3.39 per cent above the Bank of England base rate, which is also capped at 5.89 per cent until 31 January 2013, and available to customers with a maximum LTV of 80 per cent.
Neither calculation takes into account the many fluctuations that SVRs and trackers would expect to experience over a 25-year term. The average five-year fixed rate would currently cost much more, at £974.72 per month, but this would be fixed for five years. If the rate then reverted to the average SVR of 4.69 per cent for the remainder of the term, the true cost would amount to £266,733.60.
The sticking point is that, at the moment, tracker mortgages have nowhere to go but up. "Base rate is expected to stay at its historic low for the duration of 2010, but if inflation starts to get out of hand, we might see a change much sooner," says Darren Cook, of Moneyfacts.
Tracker borrowers may be able to enjoy relatively low rates just now, but they won't benefit from any further rate cuts. Once the base rate starts to climb, those on a tracker mortgage could find they are unable to keep up with monthly payments, particularly if the base rate climbs as quickly as it fell. "Trackers may seem cheap now, but the bank base is most probably going to go up as quickly as it came down, and a base rate returning to 4 per cent will result in the cheapest tracker to cost over 6 per cent in pay rate," says Mr Cook.
Even if the base rate rose by just 2 per cent, at 3.39 per cent above base rate, Legal & General's new lifetime tracker would jump to a not-so-attractive 5.39 per cent. This illustrates that, for those without a flexible budget which is able to cope with sharp rate increases, there are significant perils with lifetime trackers.
Despite these dangers, one of the most appealing things about lifetime trackers is that many have small early redemption charges, or none at all. The lifetime tracker from First Direct, for example, charges a mere £149 redemption fee, while redemption on its two-year fixed loan is 3 per cent of the mortgage advance in the first year and 2 per cent in the second year.
"Lifetime trackers appeal to borrowers who want lots of flexibility with their mortgages. These loans tend to tie the client in for the first two or three years, but after that they can switch to another deal at any time without penalty," says Melanie Bien, of mortgage broker Savills Private Finance.
With no punishment for switching to a better deal, as there is with other home loans, homeowners can, in theory, take advantage of low rates now, then switch to a fixed-rate deal if the base rate starts to rise steeply.
This still carries some risk, as fixed-rate deals are also likely to increase sharply when the base rate rises, and borrowers could miss out on securing a better deal by not fixing early. For some, the security of a fixed monthly payment will always win over playing the interest rate game. Fixed-rate mortgages are generally more expensive but do guarantee static repayments for an agreed term, which could be invaluable for anyone on a tight budget who cannot afford rising rates.
"These deals don't suit those who need the security of knowing what their mortgage payments are each month," says Ms Bien. "Base-rate trackers suit those who can cope with volatility."
Diving in 'I thought we'd be wasting our money on a fixed deal'
Chris Ginnelly, 35, who lives in a semi-detached, three-bedroom house in Twickenham, Middlesex, with his wife, Clare, 36, and their three children, is enjoying a rate of 2.47 per cent above the base rate after taking the plunge with a lifetime tracker mortgage from Woolwich.
When it was time to remortgage, in November, Chris, who works as general manager for Xerox UK, and Clare, an artist, decided to take out a tracker rather than fixing their mortgage rate.
"I did consider a fixed rate," says Chris, "but I felt that the economic recovery would start to slow again in 2010. I don't believe there will be an accelerated increase in interest rates and when I looked at the fixed rates on offer in November I thought we'd be wasting our money for at least 12 months."
As an added bonus, the mortgage allows them to offset their mortgage with their savings and suits Chris's job perfectly. "With the type of work that I do, I have an income that can fluctuate, so with the offset option it's ideal," he says.
To avoid an early redemption charges the couple will have to wait for three years to switch, but Chris is confident that they can ride out any rate increases before switching if necessary once the three years are up.
"With my first house, I got caught with an uncompetitive fixed rate and that hurt, says Chris. "Maybe I will lose out with a tracker, but overall, the mortgage suits me. I'm not too concerned, and, although I wouldn't want to, I can handle a swing."
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