When falling interest rates just happen to other people

Many households are finding that the cost of their mortgage payments has nothing to do with the official cost of borrowing. Laura Howard investigates
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The Bank of England base rate may have fallen again last week but many homeowners would be advised to hold off on the champagne as their mortgage payments might be heading in the opposite direction.

Regardless of the base rate being cut from 5.75 per cent to its current 5 per cent in the space of less than a year, lenders including Nationwide, Cheltenham & Gloucester and Alliance & Leicester have been systematically hiking up their mortgage rates while insisting on larger deposits to mitigate risk further.

This is because the price of mortgages is less to do with the Bank of England's decisions and more about the cost of funds, says Andrew Montlake at broker Cobalt Capital. "Lenders are not advancing money at the moment for two reasons. The first is that they may need the money for themselves and the second is that there is a lot of distrust: if one bank lends money to another, there is a feeling they might not get that money back. This situation is pushing up the three-month Libor [the London inter-bank offered rate], which is the rate at which banks lend to each other and ultimately how mortgages are priced."

At the time of writing, Libor stood at 5.93 per cent – which is very high given that it should run about a quarter-point lower than base rate, says Mr Montlake. "In this case, a 0.25 per cent cut in base rate here or there will not make much difference to homeowners – although it may mitigate further increases in the price of mortgages."

But while the cost of new home loans is disconnected from the base rate to some extent, there are still some links, says Ray Boulger, technical manager at broker John Charcol. "Borrowers on base-rate tracker mortgages will benefit from falling interest rates. And while the best two-year tracker was priced at base minus 0.25 per cent a year ago, against plus 0.89 per cent today, the borrower will still get an immediate financial benefit."

According to figures from Moneysupermarket.com, homeowners have already cottoned on to this. "In March last year, 13 per cent of users opted for trackers," says Louise Cuming, head of mortgages at the price-comparison site. "That figure now stands at 35 per cent as they want to be sure a falling base rate actually has some positive effect."

Homeowners paying their lender's standard variable rate (SVR) because they have a small outstanding balance or have simply not got round to remortgaging could also benefit from a falling base rate. However, this is only if the cut is passed on by lenders, which are under no obligation to do so.

"And in current conditions, I strongly suspect many will not be adjusting their SVRs accordingly," says Mr Montlake.

Although mortgage prices are rising and the number of loans available is falling – there were 8,464 separate deals at the start of the year, compared to 4,389 today, according to the Moneyfacts comparison site – it is not in lenders' best interests to freeze out every borrower, says Mr Boulger. "Banks and building societies clearly need to stay in business and keep their staff employed, so they still want mortgage customers. However, they are simply refocusing to a lower risk. This means that the premium between 95 per cent and 75 per cent loan-to-value mortgages is now a lot higher than it was this time last year."

This approach to lending doesn't offer much in the way of hope to first-time buyers, who will have to jump through an increasing number of hurdles to get a loan. Recent research from the mortgage-monitoring service mform.co.uk (see the article below) found that in March 2007, the average interest rate on the top five first-time-buyer mortgages was 5 per cent; it was 5.8 per cent in March 2008. And with Abbey becoming the last lender to ditch its 100 per cent mortgage on Tuesday, the opportunity to borrow without a deposit has gone.

But now that first-timers do have to save for a deposit, Ms Cuming at Moneysupermarket recommends they do so with the same bank or building society at which they intend to take out a mortgage. "Lenders are really starting to cherry- pick the borrowers they want to do business with, and having a track record of consistent savings could work in your favour."

If the latest house price index from the Halifax (see top left of the facing page) is anything to go by, saving for a year or two could pay off in more ways than one. The bank's survey showed that the price of the average home fell by 2.5 per cent in March, and it is predicting "low single-figure" falls over the course of the year. A 5 per cent saving on the value of the average property – £191,556, according to the Halifax – amounts to £9,578, which has got to be worth the wait.

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