So how far would you go to get a better deal?
Sunday 26 February 2006
Confused? If you weren't already, you may well be now.
While most homebuyers have to choose the right mortgage deal from a wide selection that includes short-term fixes, discounted variables, trackers, and flexible and offset loans, a band of confident borrowers are going for a still more sophisticated option: a sterling mortgage linked to the interest rate of a different country.
Launched here four and a half years ago, deals of this type still account for only a tiny percentage of the UK market. As with ethical or green mortgages, lack of borrower demand is largely matched by a lack of supply. Just four lenders bother to offer them - West Bromwich, Leeds, Derbyshire and Scarborough building societies - and mainly through broker John Charcol.
The way they work is that your loan is linked to the interest rate of one of just three countries or economic areas: the US, Switzerland and the EU.
More specifically, it is linked to what is called Libor - an acronym for the London inter-bank offer rate. This might sound complex but it is simply the rate of interest at which national banks in different countries lend to each other.
Each country has its own version of Libor that is connected to - but not the same as - its central bank's interest rate.
So the US Libor depends on rates set by the Federal Reserve, and the Euribor (an amalgamation of Euro and Libor) on the European Central Bank.
Libor tends to move in anticipation of what the country's base rate might do. For example, the US base rate currently stands at 4.5 per cent, while US Libor is 4.77 per cent. In broad terms, this means economists are expecting the Federal Reserve rate to rise.
It might seem as if you need a fine grasp of overseas economics before even contemplating this kind of mortgage. But proponents contend that with most deals running for five or 10 years - much longer than most of the deals available domestically - borrowers can afford to be more relaxed.
Ray Boulger at John Charcol points out that, historically, overseas Libor rates have been lower than those here. The idea, therefore, is to let customers benefit from potentially cheaper deals for long spells.
That said, there are short-term fluctuations - and critics contend that these can have a greater impact on borrowers than rate changes in conventional domestic mortgages.
All overseas interest deals track the relevant country's Libor by a certain margin and, critically, their price is calculated on what is known as "three-month Libor" - so any change up or down at this point is reflected in the amount of interest you pay. "Most of the mortgages linked to foreign rates that have been launched in the last few years have been tracking a very low rate [for borrowers], but at a high margin [for the lender]," says James Cotton of the broker London & Country. "The danger is that if the underlying rate rises, borrowers will end up paying much more than with deals that track the Bank of England base rate."
Two years ago, the Federal Reserve rate dived in a bid to keep a stuttering US economy going, hitting 1 per cent in June 2004. However, it has since risen back up to 4.5 per cent.
Until recently, Skipton building society offered a four-year loan that tracked US Libor at 2 per cent above. This was fine when times were good, but the rate rise is now hitting home.
"With US Libor at 4.77 per cent, anyone still on this deal could be paying 6.77 per cent from next month - higher than most lenders' standard variable rates [SVRs]," says Mr Cotton.
And in contrast to SVRs, where borrowers don't have to pay a penalty charge to remortgage away to a cheaper deal, overseas interest mortgages levy early repayment charges as high as 5 per cent.
Today, the cheapest mortgage of this sort is Derbyshire building society's Swiss Franc Libor tracker. For a five-year deal, this is priced at 2.94 per cent above that Libor - giving a current pay rate of 3.99 per cent.
Elsewhere, a US Libor tracker funded by Leeds building society is priced at 3.49 per cent until 30 June this year. From then, the rate is pegged at 0.4 per cent above US Libor.
Nick Gardner at broker Chase de Vere Mortgage Management is unimpressed: "Given that you can get lifetime trackers pegged to UK rates for 4.89 per cent or less, I see little point in linking to an American interest rate in order to get a higher rate on your mortgage."
But Mr Boulger says it's better to take a long-term view. "Although at 4.5 per cent, the Federal Reserve cost of borrowing is currently the same as the UK base rate, it's believed to be nearing the top of a [rate] cycle.
"It spent a long time at around 1 per cent when these mortgages were first launched."
Fees on overseas rate mortgages are comparable with those on standard UK loans.
Given their nature, the biggest take-up of these loans is in the buy-to-let market, adds Mr Boulger. The typical Libor deal is for five years, which means that interest rates are usually low enough in the long term to make them appealing.
Property investors comfortable with juggling several mortgages, he continues, also tend to be more adventurous about non-traditional lending.
'The rate should stay low for years'
Richard Dean, 52, is buying three buy-to-let properties in Tooting Bec, south London.
He has chosen to fund each of them on an interest-only basis using West Bromwich building society's Euribor tracker mortgage.
The deal is 2.3 per cent above Libor for two years, giving a pay rate of 4.6 per cent today, before switching to 2.8 per cent above Libor for a further three years.
"The low initial rate attracted me to the deal - and [the expectation] that it should stay low for five years," says Richard, a writer.
"The adviser assured me that, historically, this had been the case with Euribor.
"With [previous buy-to-lets] I took a short-term discount on a mainstream deal and am now paying a mug's rate. I didn't want that to happen again."
Richard is not concerned about keeping up with the movements of a foreign interest rate. "I've never been a great student of these things," he says. And being tied in for five years doesn't faze him either. "I am not intending to sell in that time so don't see the problem."
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