Why the long-term view pays off with mortgages

A 10-year fixed loan offers the best protection against interest rate rises, says Stephen Pritchard
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The Independent Online

Even though the Bank of England decided to keep interest rates at 4.5 per cent last month, mortgage lenders have started to withdraw some of their more attractive, short-term deals. Abbey is the latest to drop its 4.29 per cent, two-year fixed rate. According to broker Purely Mortgages, only Halifax now offers such a low interest rate.

This reflects the view among City economists that the Bank now looks less likely to cut interest rates in the short term. Swap rates, used by financial institutions to price loans, are 0.3 per cent higher than they were a month ago.

However, the yield curve - which determines the long-term cost of borrowing - remains relatively flat. The price of 10-year swaps, at 4.75 per cent, is only 0.09 per cent above two-year swaps and 0.02 per cent above five-year rates.

The differences in the market place are more marked. Last week, Britannia was offering a five-year fixed-rate deal at 4.39 per cent, according to John Charcol. The best seven and 15-year fixes were from Northern Rock at 4.89 per cent. Norwich and Peterborough has a 10-year fix at 4.78 per cent. Nationwide has a slightly more expensive 10-year deal at 4.89 per cent, but with the advantage of a free valuation and legal work.

"The difference in rates between the best two-year fixes and the best longer-term ones is because loss-leader rates are available for two years," says Ray Boulger, John Charcol's senior technical manager.

"Borrowers prepared to switch to a new deal every two years can take advantage of this. But they need to take into account the extra costs of changing their deal every two years. This is a particular issue for smaller mortgages."

Longer-term fixed rates do also have the disadvantage of longer-term tie-ins. Although no one can predict where interest rates are heading over time, and taking a longer-term fixed rate offers the best protection against interest rate rises, fixed-rate mortgages are not the most flexible loans on offer.

Circumstances that could make a long-term fixed rate mortgage an inappropriate option include planning to move house or even being in a position to pay off the mortgage altogether.

"If you expect to move home in a few years then it is better to go for a two or three-year fix so that you will be free to take a fresh look at the situation when it ends," says David Hollingworth, director at mortgage brokers London & Country. "Whilst mortgage deals are portable, those needing to borrow more as they step up the ladder will be limited to their existing lender's deals. These might not be competitive."

In the worst-case scenario, a homebuyer could even find that they cannot borrow enough on a larger property, because the lender's income or loan-to-value rules do not allow it. In those circumstances, the homebuyer would have to change mortgages and pay the early redemption charge. For a long-term fixed-rate deal, this could be extremely expensive.

These factors go some way to explaining why most homebuyers have steered clear of long-term fixed-rate mortgages; the fact that longer-term deals have been rather more expensive than short-term fixed or tracker rates has also put borrowers off.

That could change as more lenders rethink their interest rates for short-term mortgages, and as the market for long-term fixes attracts more competition. If borrowers see mortgage rates starting to move upwards, they may be more willing to look at a 10-year or even longer fixed rate.

"The10-year market is now more competitive, with a much wider choice of lender," says Hollingworth. "Those who perhaps can take advantage of this are those with 10 years to go on their mortgage, kids who have flown the nest and no plans to move or need to borrow more further down the line."

And, with lenders steadily increasing the cost of mortgage fees, there is something to be said for taking a longer-term view.

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