Personal Finance: Nationwide hedgs its bets with low-cost euro mortgage

Tying your mortgage to European interest rates sounds attractive, but there are still a few penalties to be paid.
MORTGAGE CUSTOMERS were this week offered their first opportunity to take up a mortgage linked to European interest rates without taking a bet on the value of sterling in the next 25 years.

Nationwide, the country's biggest building society, has announced the first mortgage to be offered in sterling that links itself to European rates. Customers are being offered a rate pegged at 1.75 per cent over the base rate set by the European Central Bank, currently 3 per cent.

The society is also offering a 1 per cent discount on the first year's payments, meaning customers will initially pay just 3.75 per cent.

Other lenders have already offered mortgages linked to euro rates. But until now there has been one big stumbling block: the risk of a change in the value of sterling relative to the euro.

Because these original Euro-mortgages will be available in sterling but pegged to euros, the repayments can rise if the pound falls in value against the euro. Until now that has put off all but the biggest risk-takers. John Charcol, the mortgage broking firm, points out that the difference between euro and sterling rates, while substantial, may not justify this risk.

Euro base rates are just 3 per cent, but the lender must take a cut. Most mortgages in Germany, for example, rarely stray below 5.5 per cent. The different between a Euro mortgage and a sterling mortgage, on variable rates, may therefore come to as little as 1 per cent.

On the plus side, British lenders add a smaller amount to base rates to cover their costs than their German counterparts. So it would seem possible for them to offer mortgages at lower rates than those offered in Germany.

What makes Nationwide's mortgage different is that the customer not only enjoys the low euro rate and a more cost-efficient lender - more importantly, Nationwide will strip out the currency risk: "We have effectively hedged the currency risk with a third-party. But we haven't said exactly what we have done because we want to hang on to that competitive advantage," said Steve Blore, a spokesman for Nationwide.

The cost of that hedging is reflected in hefty early redemption fees which lock in the borrower for no less than 10 years. If borrowers redeem within five years they will pay 9 months' interest as a penalty. To secure customers' commitment, Nationwide is also charging a pounds 295 application fee.

Borrowers may also find that by buying this mortgage this year, they could miss out on falls in sterling interest rates as the UK approaches monetary union. If, for example, British interest rates fell to the Euro rate of 3 per cent, this mortgage would charge 4.75 per cent.

Other mortgages, with no margin built in for hedging, might fall below this level. Whether the deal is worth it will depend, like much else, on how long it takes the UK to join the euro.

Ian Darby, at John Charcol, is cautious about the Nationwide's loan because of its punitive redemption penalties. He says: "If you believe our interest rates are going to converge with Europe, then why tie to redemption penalties. You can fix with the Woolwich for three years at 4.19 per cent, and repay without penalty whenever you like."

`The Independent' is offering a free 36-page Guide to Flexible Mortgages, with tips on all aspects of home loans, including how much you can borrow, how to repay the mortgage and a list of useful names and telephone numbers at the end. For your copy of the guide, sponsored by First Active, call 0800 550551