Should you nail a low mortgage rate down?
With borrowing so cheap, Kate Hughes asks if fixes of 10 years or more are a case of making hay while the sun shines
Sunday 15 February 2009
The remarkable fall in interest rates has left people on tracker mortgages rubbing their hands with glee.
But as fast as rates have dropped, so they could rise, mortgage experts warn, tempting some homeowners to call the bottom of the market and pile into fixed-rate deals as their existing arrangements end. Most people go for two or three-year fixes to lock in a low cost of borrowing, but is there money to be saved by nailing a mortgage down for five or 10 years, or even longer? Or is it a huge mistake to tie yourself to what could prove a highly uncompetitive deal?
With the base rate at its lowest level since the Bank of England was founded in the 17th century, mortgage deals, at least for those who are particularly creditworthy, are very low. But at least one prominent high-street bank has said it will no longer pass on further base rate reductions to customers, and many people reckon this is as low as most rates will go. What's more, if the UK's economic past holds any lessons, it is that huge government borrowing – as we are seeing today – leads to higher interest rates in the future.
Against this kind of backdrop, it is no surprise that fixes are becoming increasingly popular. Among the best two-year deals on offer is the 3.49 per cent from Royal Bank of Scotland, with a maximum loan-to-value (LTV) of 75 per cent and a fee of £799. This is slightly higher than some of the other types of mortgage available today, but the idea is that over the fixed period, rates in general will rise about that level, so ultimately you save money.
But in that case, might homeowners be missing a trick if they don't fix for longer now that interest rates are so low? Locking yourself into a deal for a decade, for example, will make long-term budgeting far easier, with the potential for a nasty and sudden increase in your rates banished to far in the future. And with such an extended duration, you avoid having to pay out fees for remortgaging every few years. These can often be set at £1,000 or more, along with the additional legal and valuation costs.
"The advantage of a fix for five, seven or 10 years is that it will buy you peace of mind for a good length of time without tying you in for too long," says Melanie Bien, director of mortgage broker Savills Private Finance. "And if you have a deal on a high LTV, this might be particularly useful as property prices are likely to fall further before they stabilise. If you opt for a two-year fix, you may struggle to get another attractive rate when you remortgage as your LTV could be even higher and lenders may not have returned to this market."
Longer fixes may be well be set above the current base rate, but they are still historically very low and fees are comparable to most other mortgage arrangements. The best five-year deal available at the moment is from Alliance & Leicester, which is offering 4.44 per cent on a maximum LTV of 60 per cent, though the product comes with a restrictive maximum loan of £100,000 and a fee of £1,499. For both seven and 10-year fixes, Skipton building society offers a rate of 4.79 per cent at 60 per cent LTV and £895 in fees.
But if you're locked into a long-term mortgage, you could have an expensive problem if your personal circumstances change and you are forced to redeem your loan early. Fees for early repayment can be set at such a level that the interest you would have saved over the years is wiped out. You could even be left out of pocket.
"Early repayment charges are certainly one of the big disadvantages of fixing for longer than two or three years," Ms Bien warns. "Shorter deals are so popular because borrowers welcome the flexibility as they know what they will be doing during that time. This is not always the case with a longer deal so don't fix for 10 or 15 years if there is a strong possibility that you will move house inside two years."
At the extreme end of the scale, 25-year deals have long been championed by Gordon Brown and Alistair Darling (pictured) as a way of protecting consumers from fluctuating interest rates. In 2004 the Government commissioned a report on the mortgage market that identified selling more 25-year fixes as the key to bringing long-term stability to the housing market. Post credit crunch, this has proved a hollow aim as the number of 25-year deals has shrunk to almost zero, with lenders not willing to spend money marketing what has proved a very marginal product.
What's more, a very long-term lock-in like this means there's even more time for things to go wrong, warns David Hollingworth of broker London & Country Mortgages, and not just in terms of early repayment charges.
"The 'portability' of this type of mortgage can cause tremendous funding problems for people wanting to move house, especially for those who want to upsize," he says. "If you need additional borrowing, you may be limited to what your existing lender is willing to advance to you, if anything.
"It could be a case of giving up the property you want to buy, or paying huge penalties to get out of your deal."
In fact, Kent Reliance building society is the only lender still offering 25-year deals, currently 5.98 per cent for a £995 fee, and a 3 per cent early repayment charge for the full 25 years.
But Mr Hollingworth is a fan of 10-year fixes: "The premium people are being asked to pay for a 10-year deal isn't that much and there is plenty of choice out there."
Meanwhile, in light of the recent rate cuts, the interest on 25-year products can mean existing customers are paying well over the odds. In fact, those who took Mr Brown's advice are down thousands of pounds after only four years, says Louise Cuming at price-comparison site Moneysupermarket.com.
By 2011, a borrower who took out a 25-year fixed-term mortgage of £100,000 in 2007 can expect to be £4,200 worse off than someone who got successive two-year fixes, according to the website's figures. "Many of those people who listened to Gordon Brown must be crying into their porridge each morning," adds Ms Cuming. "It underlines the danger of locking yourself in so long into the future.
"Borrowers on a 25-year deal must now be wondering whether to stick with a mortgage at around 6 per cent and watch their savings rates dwindle, or to take the unsavoury step of paying an early redemption charge of at least 3 per cent of the value of their mortgage."
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