Expensive to escape from fixed-rate trap: Redemption costs can outweigh savings on interest. Maria Scott reports

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The Independent Online
'TRAPPED with a fixed interest Rate of 10.9 per cent . . . we may be able to help - act now]'

These were the enticing words in an advertisement placed recently in a south London newspaper by Pickering Financial Services, an agent for life insurer Provident Mutual,

Borrowers with fixed-rate loans normally face penalties - of up to six months' interest - if they want to pull out of the deal before the fixed-rate period has expired.

In fact, Pickering has no magic answers for those lumbered with high-priced loans. Callers are told that some people are cashing in endowment policies to pay the penalties. Alternatively, they can raise a loan. Cashing in endowments early is generally thought to be unwise, because the policyholder may receive substantially less than the premiums paid, especially if the policy has only been running a few years. Regulators frown on advisers who encourage this, particularly if they will earn commission.

Pickering, however, seems aware of the risks. It does not recommend early surrender 'unless it is a final resort'.

Bill Brown, head of appointed representatives with Provident Mutual, said it was not policy to encourage people to surrender endowments to release themselves from fixed- rate loans. He was satisfied Pickering was not doing this.

However, the firm's advertisement highlights a problem now faced by people who took out fixed-rate loans a year or more ago, often over long periods, at 10 per cent or above. The standard mortgage rate is now 7.99 per cent and there are fixed-rate deals available at less than 5 per cent.

For example, National Westminster Bank launched a range of five-year and 10-year fixed-rate deals in 1991 at rates up to 11.8 per cent. The 10-year loans had redemption penalties of six months' interest. NatWest now offers fixed-rate deals from 6.75 per cent over two years to 9.69 per cent over 15, 20 and 25 years.

John Campbell, manager of campaign planning, said the bank was willing to negotiate on redemption penalties if the borrower wanted to switch into a new fixed rate with NatWest. 'We look at each case on its merits. It depends on how long the customer has had the loan and the price the bank bought the money for.'

Even if the penalties can be reduced, borrowers still face considerable costs in unwinding a fixed-rate loan. There may be further valuation and arrangement fees to pay.

The upfront costs must be weighed against the interest savings, but a switch can be worthwhile and need not entail cashing in an endowment.

Some lenders, such as Barclays, will allow borrowers to add redemption penalties to their mortgages to cushion the blow. The bank calculates that the total remortgage costs for people switching from a five- year fixed-interest loan at 10.5 per cent, with three years to run, would typically be pounds 1,860, assuming they go for the bank's current five-year deal at 7.99 per cent. This includes pounds 1,300 in redemption penalties, an arrangement fee of pounds 100, a pounds 200 booking fee, valuation fees of pounds 110 and legal costs of pounds 150.

Monthly payments on the 10.5 per cent loan would be pounds 414. Payments on the 7.99 per cent loan would be pounds 343.

Over three years, the borrower would save pounds 2,556 in interest, which would outweigh the pounds 1,860 redemption penalty. After the remortgage costs, the net saving would be pounds 696.

If the borrower could not pay the remortgage costs upfront, Barclays would normally allow the redemption penalties and arrangement fee - a total of pounds 1,400 in this example - to be added to the loan. This would bump the original mortgage up to pounds 51,400. The monthly payment on this under the new fix would be pounds 354. Over three years, the saving would be pounds 2,160. This falls to pounds 1,700 after the borrower takes into account the pounds 460 in upfront costs they would still have to find themselves.

However, borrowers should note that the extra pounds 1,400 borrowed adds pounds 3,276 to the total cost of the mortgage over 25 years, if the rate stays at 7.99. So assuming they are only two years into the term when the fix is switched, they face a total cost for the remaining 23 years of pounds 3,036. When the extra pounds 460 of up-front costs is added, this rises to pounds 3,496.

This well and truly wipes out savings over three years, but borrowers may not want to take such a long-term view.

(Photograph omitted)