So much for peace of mind. Borrowers seek glimmer of hope as the cheap fixes end

With hundreds of thousands of households facing huge hikes in their mortgage payments, Esther Shaw sees how they might limit the damage
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The Independent Online

July could prove an extremely tough month for borrowers who are about to come to the end of a cheap fixed-rate mortgage. The cost of these deals is soaring, leaving many already overstretched homeowners facing a steep hike in their monthly payments.

"There will be 240,000 households trying to renew their fixed deals this month," says Louise Cuming at the price-comparison service "These are made up of people coming to the end of three-year fixes from July 2005, when the average rate was 5.12 per cent, and those nearing the end of two-year fixes taken out when the figure was 5.18 per cent." Those figures now stand at an average of 7.26 and 7.05 per cent respectively, according to financial analyst Moneyfacts.

Borrowers looking to fix their mortgage for five years are also paying the price, as the average rate has now increased to 6.92 per cent.

"Fixed-rate deals have only been going one way – up," says David Hollingworth from broker London and Country. "This is as a result of the growing expectation of the Bank of England base rate going up – a complete shift away from recent speculation that rates were likely to fall."

"Two-year swap rates [the price at which banks lend to each other] dictate the future movement of fixed mortgages, and these have soared in recent weeks on the back of fears that the base rate will have to rise to keep inflation in check," says Melanie Bien from broker Savills Private Finance. "This has led to lenders repricing fixed rates higher. The cost of two-year money has since fallen a little but two-year fixes continue to look expensive."

So what should borrowers do now? They may be able to get a cheaper variable-rate deal, but given the bleak outlook for both inflation and the cost of borrowing in the short term, they run the risk of a *even bigger hit to their wallets.

"With the money markets factoring in base rate increases, those on tight budgets will continue to need the certainty of a fixed rate," says Ms Bien.

Mr Hollingworth agrees: "Knowing exactly what you have to pay may be particularly important at the moment, against a backdrop of rising fuel and food bills."

The key, then, is to scour the market for the best deals, though these tend to come with sizeable arrangement fees. Mr Hollingworth picks out a two-year offer from First Direct at 5.98 per cent with a £1,998 fee, and a two-year fix from Chelsea building society at 6.19 per cent with a £995 charge.

"Yorkshire building society also has a two-year fix with a low rate of 5.99 per cent, but this comes with a bigger fee of £1,995," he adds. "If you want a five-year fix, First Direct looks good with a rate of 6.29 per cent and a £598 fee, while once again Yorkshire wins on rates at 5.99 per cent, but at the expense of a £2,495 fee."

Another option for struggling borrowers might be a fix of up to 10 years. "As longer-term swap rates are lower than those for short-term money, these deals could become more competitive," says Ms Bien. "They buy you peace of mind and you won't fhave to pay remortgaging costs every couple of years."

She picks out a new 10-year deal from Abbey at 6.24 per cent with a £999 fee, but warns that borrowers need to beware of the charges for early repayment.

On the other hand, for those who don't think they need the security of a fix, a better option may be a tracker or discount deal. "These continue to look comparatively attractive but there is the threat of an increase in interest rates," says Ms Bien. "For this reason, you should only opt for one of these deals if you can afford to be wrong."

While the average variable rate for two-year deals is 6.69 per cent, there are a few two-year tracker mortgages below 6 per cent. "One of the cheapest is from Yorkshire at 5.89 per cent," says Darren Cook at Moneyfacts. "But this comes with a massive £1,995 fee."

Elsewhere, Ms Bien picks out a discount deal from HSBC at 5.49 per cent – 0.76 percentage points below the bank's standard variable rate (SVR). It lasts for two years and has a £999 fee.

She adds that some borrowers may be tempted to go on to their lender's SVR at the moment, as this may well be cheaper than some of the two-year fixes on offer. The average SVR currently stands at 7.01 per cent, according to Moneyfacts.

"The added advantage is that most lenders are not charging an arrangement fee for moving on to the SVR, and not levying a penalty if you find an attractive fix or tracker at a later date and want to switch," says Ms Bien. "But again you are exposed to fluctuations in rates."

One new product that might be worth considering is "interest rate insurance". Launched last week by MarketGuard, it gives borrowers the chance to hedge against the threat of rate rises.

Customers specify a rate – either 1, 1.5, 2 or 2.5 per cent above the base rate and the policyholder's mortgage rate at the time – and pay for cover for two years. If both of these rise by more than the chosen figure, the insurance will pay out.

"If you believe rates are going to rocket then there will clearly be some merit in this product," says Drew Wotherspoon of broker Charcol. "But they would have to go up by well over 1 per cent in two years for there to be value."

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