Research will bring rewards

With interest rate cuts in the offing, canny investors should shop around, says Stephen Pritchard

The coming year could bring good news for home-owners, especially those who are able to keep a close eye on the financial markets.

With house prices relatively subdued in 2005 and limited inflationary pressure in the wider economy, many City observers expect the Bank of England to make cuts to interest rates. John Charcol, the mortgage broker, expects to see up to three base rate cuts in 2006, amounting to a drop of 0.75 per cent.

Home-owners with variable rate and, especially, tracker mortgages should see a fall in their monthly costs. But lower interest rates should also feed through to fixed and discounted loan deals, as lenders re-price these to reflect the markets.

"There is little or no premium to pay for taking a fixed rate compared to discounts or trackers," says James Cotton, a mortgage specialist at London & Country. But in the short term, at least, tracker loans could be cheaper as they fall with the base rates.

Offset mortgages - where a borrower's savings are used to cut their total interest bill - could also grow in popularity. Cotton points out that the margin between offset and regular mortgage deals fell in 2005, as more lenders entered the market.

This should encourage more borrowers to look at these loans, as will the lower savings rates that inevitably follow interest rate cuts. Last year also saw some lenders launch fixed-rate offset mortgages, and 2006 could see more of these.

For home-buyers, the choice of loan rates will depend to a great extent on what is on offer at the time they want to purchase. The best mortgage option will depend, in part, on the amount of money they need to borrow.

Buyers with relatively small mortgages may well find that it is best to take one of the current crop of fixed-rate or tracker mortgages, rather than hold out for future cuts in base rates. The cost of lenders' arrangement fees - now in the range of £500 to £700 - could easily outweigh a small saving in interest rates, especially for loans of £50,000 to £100,000.

For large mortgages, however, it could pay a buyer to take out a flexible initial deal, such as a tracker mortgage with no early redemption penalty, with a view to moving deals should interest rates drop. "It does depend on the mortgage size," says Ray Boulger, senior technical manager at mortgage brokers John Charcol. "For a £50,000 mortgage it is not viable to switch, but if you are borrowing £1m it is."

Home-owners looking to remortgage do, at least, have a little more flexibility when it comes to timing. But anyone coming to the end of a fixed or discount rate, and who faces the prospect of paying their mortgage company's standard variable rate, should act quickly. Standard variable rates (SVR) are typically priced about two per cent higher than market leading deals.

This differential means that it is almost always worth arranging a new mortgage to tie in with the existing loan. And the larger the mortgage, the greater the urgency. "At the end of the day you do not want to spend several months paying the SVR," says Boulger. "Paying two per cent more for a few months might more than outweigh the benefit of a lower rate."

Home-owners who believe that interest rates will fall this year could, of course, opt for a tracker mortgage. That way, they will benefit immediately from any cuts to the base rate. Another option is to pick a tracker or discounted mortgage with no early redemption penalties, with a view to moving to a fixed-rate mortgage later, if rates appear to have hit the bottom.

John Charcol offers a mortgage with the Clydesdale that offers a formal "drop lock" facility, whereby borrowers can move to a fixed rate at no charge. And a couple of lenders, including Woolwich and Accord, are offering new business rates to existing borrowers in order to encourage loyalty.

Picking a lender that makes it easy to switch is one way to hedge your bets - but it will only pay for buyers who pay attention to the mortgage market.