Personal Finance: Borrowers hoping a little is enough

Interest rates are up to 5.5, what is going to happen to mortgages? asks John Willcock

FIRST THE bad news. Mortgage rates are going up. The good news is that they won't go up anything as far as people were expecting, even until very recently.

The Bank of England's decision on Thursday to raise rates to 5.5 per cent was widely expected, and will not make a huge difference to the mortgage lenders. But the UK's economy is bouncing back from near recession earlier this year much faster than anticipated. Soaring house prices and higher pay settlements will almost certainly prompt further rate rises, as the Bank tries to take the steam out of an overheating economy.

The consensus from the City is that interest rates will probably peak at about 6.5 per cent next summer. What will this do to mortgage rates? This isn't as obvious question as it first appears, since we now have quite a spread of rates from the competing lenders.

For instance, before this week's announcement, the big boys like the Halifax and the Abbey National both had a Standard Variable Rate (SVR) of 6.99 per cent. Then the yet-to-be-demutualised Bradford & Bingley came in with 6.85 per cent, followed by the Leeds & Holbeck, which took the brave decision this week not to raise its rates at all until the New Year. The Leeds & Holbeck is sticking at 6.79 per cent. Then you go down to the Nationwide with just 6.45 per cent.

A back of the envelope calculation suggests that these lenders will probably raise their rates by next summer to between 7.45 per cent and nearly 8 per cent.

The question is, should you do anything about it? Remortgaging has been the rage this year, but as interest rates have edged up, the chance to lock in to fixed interest mortgages has receded. There are still some good deals around, but the absolute priority here is to beware the hidden penalties.

As it has become more difficult for lenders to make fixed mortgages pay, so they have loaded them up with more and more onerous conditions. The worst are redemption penalties. Remember these penalties may cause you huge expense if you unexpectedly have to move home or switch mortgages.

To return to our crystal ball gazing, house price inflation was a key reason cited by the Bank of England when they last raised rates in September. Halifax , Britain's largest mortgage lender, said this week house prices rose 2.8 per cent in October, the fastest since a 3.6 per cent gain in September 1998. The funny thing is, if you look around the high street you will see that many prices are going down, not up.

The invasion of the American discount superstore chain Wal-Mart, which has bought Asda and slashed its prices, is just one example. The new craze of buying over the Internet is another. And the introduction of the euro on the Continent has suddenly made it possible to compare prices across Europe with those in "Rip-off Britain".

Ray Boulger, a mortgage specialist with John Charcol, reckons that previous fears that the Bank would raise interest rates as high as 7.5 per cent next summer are fast receding. "I think the pressure from the housing market to raise rates won't be nearly as great as some say," Mr Boulger said. There are some pessimists on inflation around, however. Mark Miller, of American investment bank Morgan Stanley, reckons wages and house prices will force higher rises: "We are going for rates at 6.5 per cent at the end of next year, peaking at 7.0 to 7.5 per cent in 2001."

From this perspective, hunting down any surviving fixed-rate mortgage deals may still look good. Although these deals are evaporating fast.

Most City economists are expecting the Bank to move again in February. The Bank of England's wise men and women who set interest rates, the Monetary Policy Committee (MPC), meet again before Christmas, on the 8 and 9 December. They are unlikely to play Scrooge, however, and will keep their medicine for the Millennium hangover in the Spring. Merry Christmas, everybody.