The key question: fixed or discounted variable?

Click to follow
The increasingly fierce battle in the fixed rate mortgage market is beginning to alter the equation for those trying to decide what sort of mortgage to take out.

Saddled with fixed rate deals which have not been selling, lenders have been searching for a lifeline. Last week they got it when the Chancellor resisted pressure to raise interest rates. Money suddenly became cheaper on the wholesale markets , allowing lenders to price fixed rate mortgages more aggressively.

The comparable arithmetic on fixed and discounted variable rate mortgages can now be down to the decimal point, depending on which products you compare. But the penalties for redemption are getting harsher as the price gets cheaper, making shopping around more important than ever.

There are only two advantages of fixed rate mortgages, currently between 5.75 and 7 per cent over two years and just under 9 per cent for five. The first is as a cushion against future interest rates. If you think rates will be higher on average over the period then they are a good bet.

The second advantage is where money is tight in the first years of a mortgage and the borrower needs a guaranteed monthly payment.

The TSB's new five year fixed rate deal is regarded as cheap at 8.6 per cent. But will rates average over 9 per cent for five years? What looked like a certain rate rise at the start of the week now looks less so. Even if it comes next month the peak in interest rates may be lower than has been forecast

In the shorter term, however, there is little to choose between fixed and discounted variable. For example, a two year fixed rate from Northern Rock Building Society costs 5.49 per cent. That compares with a two year discounted rate of 5.0 per cent from Principality Building Society. Perhaps the half per cent premium is worth it if you are worried about more rate rises.

But it is unlikely that the standard variable rate (Halifax 8.35 per cent) will drop below 5. 5 per cent before the spring of 1997, so the choice depends on how long you will be locked in.

The lowest two year fixed rate deals typically lock in customers for four to five years. If the standard variable rate is high this could be a significiant cost. And penalties for redemption. Northern Rock's two year fixed deal costs four months interest at its 8.54 per cent variable rate if you quit within three years.

Larger lenders such as the Halifax and Abbey National offer 1 year discounted rates of 3.15 per cent - a saving of pounds 166 a month gross on an average pounds 50,000 mortgage. But woe betide you if you want to switch lenders within 3 years.