As mortgage rates go up, now is the time to gamble wisely
Most interest rate increases will take effect on Thursday, so now is the time to act, says David Prosser
Saturday 27 January 2007
All of Britain's leading mortgage providers will on Thursday raise the cost of their home loans for new and existing customers alike, following the Bank of England's decision to raise base rates earlier this month. Almost all lenders are passing the 0.25 percentage point rate rise on in full, though some are going even further. At Alliance & Leicester and Royal Bank of Scotland, the increase is 0.30 percentage points.
Now that borrowers know how lenders have responded to the base rate rise, they must decide what to do with their mortgages But there's no one right answer: the best strategy depends on your current financial circumstances, your views about what might happen next and your ability to gamble on those views.
"One more rise in the cost of my mortgage would make the repayments unaffordable."
If you're already stretched close to breaking point by the cost of your mortgage, take action now. Economists are divided on whether the Bank of England will raise base rates again this year, but it is certainly possible. The most obvious option for people in this situation is to fix their mortgage rate as soon as possible, to be sure their monthly repayments won't rise for a set period.
"Fixed rates are higher than they have been but still historically low," says Melanie Bien of mortgage adviser Savills Private Finance. The cheapest deal right now, she says, is Bradford & Bingley's offer of 4.99 per cent for two years, with an arrangement fee of £695.
However, Nick Gardner, of adviser Chase de Vere Mortgage Management, points out that if you are currently paying a rate below the cheapest fixes now available - around 5 per cent - this option isn't much use.
"The most effective option for a short-term crisis like this would probably be to switch to an interest-only mortgage until your financial situation improves or rates come back down," says Gardner.
On a £150,000 mortgage costing 5 per cent, the monthly cost would be about £876 with a repayment mortgage, but this would fall to £625 for borrowers who paid only the interest due.
"This is only a short-term solution since you will have to make overpayments in the future to repay your mortgage within its original term," warns Gardner. "If money is still very tight it may mean extending your mortgage term, but this should be avoided if possible because it will cost you more in total interest charges."
"My mortgage repayments are affordable and would be even if rates rise further. But I don't want to pay more than I have to so is a fix the right move?"
The rates lenders are charging each other on the professional money markets suggest they expect at least one more base rate rise this year - possibly two. On the other hand, the market is also pricing in falling rates from the beginning of 2008 - rates could be back below today's levels within two years.
That leaves the debate between fixed and variable-rate mortgages pretty finely balanced. "The truth is that no one really knows where rates will go," says David Hollingworth of adviser London & Country.
"The best of the two-year fixes would cap your costs at or around 5 per cent," Gardner adds. "Cheltenham & Gloucester has a two-year fix costing 4.95 per cent with free valuation and legal work for remortgages and a £999 fee."
If rates do rise significantly this year and then fail to fall quickly in 2008, that would be cheaper than the best variable rate discounted deal. But the latter could prove decent value too over time, if rates don't go up again, or fall more sharply next year.
"Variable rates are looking more attractive than fixes at the moment, so if you can afford to be wrong - if you will still be able to afford the mortgage if rates do increase - you may be better off," says Bien. For example, Yorkshire Building Society offers a two-year discount of 2.1 per cent off its standard variable rate - a pay-rate of 4.80 per cent today - with a £595 fee.
Hollingworth says: "If you are still uncertain about whether you want to fix you could consider mixing and matching with a fix, but watch out for paying two arrangement fees."
Gardner concludes: "As a rule, I'd say trying to time the market like this is too risky, so given the possibility of higher rates to come in the short term, take a good fixed rate and relax for a couple of years."
"Affordability isn't an issue. What's the cheapest deal?"
Discounted variable rates are slightly cheaper than fixed for now but that probably won't be the case for long. There are also lower rates available if you want to pay big fees, which can make sense on very large mortgages.
"It really is a matter of working out the total cost, all fees and interest payments included, against a variety of the market-leading deals and seeing which one suits best," says Gardner. "Choosing the best mortgage is more complicated now than ever because of the array of rates and different fees."
Hollingworth adds: "It's generally worth going for a variable rate discount that tracks rates up and down so that lenders can't raise by more than the base rate hike. Make sure you compare all deals on a like for like basis."
What now for savers?
* Interest rate rises should be good news for people with savings accounts, but two-thirds of providers have still to announce they will pass on the higher rates to customers. Among providers that have announced rate changes, not all are passing on the full 0.25 percentage points on every account, so savers need to be vigilant.
* With inflation now running at 3 per cent, basic rate taxpayers need to be earning at least 3.75 per cent a year unless they want to be worse off, after the effects of price rises and tax. The figure rises to 5 per cent for higher-rate taxpayers.
* The best buy tables published in Save & Spend will help you to identify the latest deals. But it is also worth considering National Savings & Investments' inflation-linked certificates. These pay the retail price index rate of inflation - currently 4.4 per cent - plus 1.15 or 1.1 per cent as long as you are prepared to lock your money up for three or five years respectively.
* Fixed-rate savings accounts are worth considering too, as long as you don't need access to your cash for the term of the fix.
* "The fixed-rate market now offers more than 6 per cent a year," says Lisa Taylor of Moneyfacts, "but we may see more deals coming out over the next few weeks."
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