Personal Finance: Beware the quick fix

A SERIOUS mis-match is developing in the mortgage market.

Home owners, and would-be home owners, want to take fixed-rate loans. But the lenders want them to opt for variable rates.

This is not simply because all the smart money is on rates rising. Lenders go into the money market and swap their rates, so they are not exposed to swings once they have lent at fixed rates.

But they have been unable to lock borrowers into seriously uncompetitive rates in times of rapidly falling rates, and cannot fix penalties high enough to compensate for losses.

And fierce competition has shaved the margins they can make on fixed-rate loans.

Building societies have an extra problem. They are allowed to take only 40 per cent of their funds from the money markets. The rest has to come from savers, to preserve the tradition of societies, which serve both savers and borrowers. The societies fear action from their regulator, the Building Societies Commission, and so keep well below the 40 per cent ceiling.

So what has been happening is that ordinary variable- rate loans have been made to seem competitive, with special short-term temptations.

There are discounts, cash hand-outs and free valuations that can easily add up to savings of over pounds 1,000. Northern Rock Building Society, for instance, says its deal for a pounds 60,000 loan on an pounds 80,000 property would save nearly pounds 3,000.

What leads the lenders to be so generous you might wonder? I suspect that once rates start rising, not only will those borrowers on variable rates have to start paying a lot more each month, but lenders are likely to widen their margins to take an extra bite from the diminishing band of borrowers who pledge themselves to pay unknown amounts with no debate for years into the future.

Britain's largest mortgage lender, the Halifax Building Society, has a new wheeze to keep people off fixed rates. It has fixed rates that run until the end of January 1996 or 1997. But there are penalties if you do not then go on to a variable-rate loan until the end of July 1997. For those who take the two-year fix, that means a year and a half at the mercy of variable rates.

The only alternative is to pay the three months' interest penalty. A Halifax spokeswoman said the penalty outran the life of the fix because the fixed rates were so competitive - 6.6 per cent for two years and 7.3 per cent for three years.

In other words, the society was bent on making up its profit margin at a later date.

It is a real lesson that those looking for a fixed-rate loan should look beyond the headline rate. The small print could contain clauses that make a seemingly cheap rate not so cheap after all.

The redemption penalty system looks due for a shake- up. Lloyds Bank, for instance, still charges a flat rate - three months' interest on a two-year loan and six months on a 10-year fix. So whether you want to get out of the loan after six months or after nine years and six months, the penalty is the same.

Others have moved to a declining system. On a five- year loan from the Leeds, for instance, the penalty is three months' interest in the first year, two in the second and one month's interest in the following three years.

But Barclays Bank is about to change the rules and start charging a sum related to the change in interest rates. It generously points out that anyone wanting to take a higher rate need not pay a penalty. But anyone who has taken out a loan and seen rates plummet must pay through the nose.

So a borrower with a pounds 40,000 loan fixed for five years, taken out three years ago, would have to pay a rate relating to the going rate for two-year loans - 8.5 per cent. This works out at pounds 2,352 - even more than the stiff six months' interest that Barclays would have charged under its old system.