A quick fix - with strings attached

Your cheap mortgage may look desirable now, but you could well feel trapped when it ends, says Sophie Tullis
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ALTHOUGH the Bank of England cut interest rates earlier this month, most mortgage lenders are still charging a standard rate of around 8.7 per cent. So many borrowers will get a better deal by taking out a fixed, capped or discounted loan.

Home buyers can choose from deals offering rates as low as 4.5 per cent, saving thousands of pounds on payments compared with the standard rate. But be aware of the pitfalls and hidden costs involved in taking out the special rates.

Top of the list is redemption penalties. This is the fee for stopping or paying off a mortgage early, usually while the fixed rate still applies. Typical redemption penalties are around six months' interest, which on a pounds 100,000 loan could add up to pounds 3,000.

The nastiest redemption penalties (sometimes called early repayment penalties) are where the lender ties you in to a loan long after the end of the special mortgage rate. These tend to be attached to the deals with the lowest rate.

For example, a Northern Rock product is hitting the best-buy tables offering a two-year fix for 3.99 per cent. But the payoff for Northern Rock is a five-year "lock in". Borrowers will be tied to the Rock's standard variable rate for three years after the end of the fixed period or pay up to 5 per cent of the loan to move to a cheaper deal elsewhere.

So why do lenders charge lock-ins? They say it is impossible to afford deeply discounted rates without them. They also protest that if there were no penalties, customers could easily switch lenders at no cost in search of the best deals.

Despite this, lock-ins that last beyond the period of the special rate have met with disapproval from the Office of Fair Trading. The watchdog is questioning the legality of lenders locking borrowers into whatever rates they want to charge.

The OFT is reacting to complaints from home buyers who took out special rates a couple of years ago but are now hitting a massive payment shock when shifting on to the higher current standard variable rate. When they want to move to get a better deal they hit a second shock when they realise they can't leave without paying heavily for the privilege.

For customers wary of extended lock-ins there are a growing number of products available without them. Abbey National banned all "overhanging" redemption penalties on its mortgages earlier this month, so there will be no fee to pay if you leave a special deal as soon as it ends. Abbey National business sales director, Basil Larkins, says: "Customers and financial advisers were saying that they did not want them. They wanted straightforward products that did not have things hidden in the small print."

But brokers prefer lenders to offer a choice of mortgages that come with or without extended tie-ins. Nationwide Building Society has been offering the choice for two years. More recently, high street banks such as Halifax and Alliance & Leicester have shifted to offer both options on their products. Northern Rock also offers alternatives to its lengthy lock-ins. In the case of its 3.99 per cent deal mentioned above, there is an equivalent two-year fix on offer with no "overhang" at 6.69 per cent.

So what are mortgage brokers recommending? It is possible to get good rates with no redemption penalties at all, according to John Charcol. The broker says these deals are its best-selling loans at the moment. Ian Darby, the firm's marketing director, says his clients like Portman's two-year fix (currently 6.85 per cent).

Robert Clifford, managing director of mortgage broker MPI, particularly likes fixes from the Yorkshire Building Society.

Even so, both brokers are strongly against moves to abandon extended tie-ins, which they believe will lead to more expensive rates. Mr Clifford says; "It would be dreadful if they vetoed lock-ins because it would get rid of the competitive edge of the sector. There is a place for low-price products that impose a period of tie-in beyond the initial price, provided clients are more aware of the implications."

He says there is an obvious drawback to taking out loans without extended tie-ins because it means customers miss out on the lower rates. Those on tight budgets such as first-time buyers could end up being squeezed out of the market.

Borrowers need to weigh up the immediate benefits against the cost associated with the mortgage. If you are on a tight budget then you might want the cheapest deal. But also look at arrangement fees and compulsory insurances. House insurances bought from a lender are not competitive and you should get a quote from a cheap provider (try a couple of the direct lenders) to compare costs. You may even save money paying a slightly higher interest rate but being free to buy your own insurance.

Contacts: Abbey National, 0800 555100; Alliance & Leicester, 0845 303 3000; Halifax, 0800 203049; John Charcol, 0800 718191; MPI, 01332 258000; Nationwide BS, 0800 302010; Northern Rock, 0845 605 0500; Portman BS, 01202 292444; Yorkshire BS, 0800 378836.

where to find the best deals

You can get mortgage information from best-buy tables in newspapers (check the redemption penalties, not just the interest rate).

If you have access to a fax with a handset, independent statistics firm Moneyfacts will send over the latest deals (seven pages). Pick up the handset and dial 0336 400239. Calls are charged at 50p a minute.

A good independent mortgage broker or independent financial adviser will offer a selection of the best deals. You may have to pay an extra fee. Check that a broker abides by the Mortgage Code.

The following websites have lots of mortgage information: www.moneynet.co.uk; www.moneyworld.co.uk; www.johncharcol.co.uk