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Don't be afraid to get locked in

The end is near for special mortgages, writes Gregor Paul, so low rates score over penalties
Thanks to the bad publicity surrounding old-fashioned mortgage deals with harsh penalties in the small print, many new fixed or discounted mortgages do not have any penalty clauses. In return for paying a slightly higher interest rate you will not be tied into standard mortgage rates for months (or years) after the special offer ends.

Deals that do have "tie-ins" offer lower headline interest rates but will force you to pay standard rates at the end of the initial deal.

Current thinking is that borrowers with no tie-ins compensate for paying more interest early on by being able to switch into another subsidised special offer as soon as their fixed or discounted period expires.

This theory is based on the assumption that the lending market will be able to support an indefinite number of discounted deals.

However, this may no longer be the case.

New research from an independent broker suggests you would be better off going for the best possible interest rate now - regardless of the tie-in - and gambling that you will get a good standard deal later on.

Independent Mortgage Collection is using statistics published by the Council of Mortgage Lenders (CML) to predict that by 2002 only 15 per cent of mortgages will be taken out on standard variable rates. Lenders introduced fixed rates, capped rates, discounts and cashbacks 10 years ago to counter the effects of recession. The give-away deals were subsidised by the vast majority of existing borrowers who were paying the standard variable rate.

Simon Knight, chief executive of Independent Mortgage Collection, says: "In 1995 the CML conducted a survey that found 80 per cent of existing borrowers were paying the standard variable rate. We estimate that 45 per cent of existing borrowers are today paying the standard variable rate. We believe only 15 per cent of borrowers will be paying the standard rate in three years."

Mr Knight believes the pool of funds that lenders have been using to subsidise special deals will dry up by 2002 and that all borrowers will be offered the same rate, removing the opportunity to remortgage and take advantage of another fixed, capped or discounted loan.

He feels borrowers could be best advised to take the best subsidised deal they can get today and forget about the redemption overhang.

Mr Knight says: "It is a racing certainty that the existing borrowers who provide the subsidies for new business offers will disappear in a few years' time. If in three years there are no special deals to remortgage into then people should opt for the tied mortgage now and reap the benefits of the lower rates of interest."

Other leading mortgage brokers follow a different line of thinking to reach the same conclusion. They argue that in three years the mortgage market will be dominated by loans that track the Bank of England base rate. Loans that guarantee never to be higher than 1.75 per cent above the base rate are offered by a number of big lenders including Abbey National, Coventry BS and the Woolwich. This trend is set to accelerate. Economic experts predict that interest rates will stay low as the UK gears up to join the euro. Mark Chilton, managing director of mortgage broker Savills Private Finance, says: "Tracker loans are becoming increasingly popular and will dominate the market in three years. Ultimately, this will level the market and all borrowers will be paying the same rate."

But Mr Chilton sounds a note of caution: "Consumers need to be carefully advised and fully understand the redemption penalty attached to the loan. As long as they understand the implications then there should be no problems."

Mr Knight says: "The time to worry about redemption tie-ins was three years ago. As long as you are taking a loan from a well-known lender that cannot afford the bad publicity associated with over-charging, borrowers are advised to take the best subsidy they can find today."

This approach may not suit everyone but it is worth thinking about if you know you won't want to change your mortgage deal before the tie-in ends.

n Gregor Paul writes for `Money Marketing'.