The Fixed Rate Conundrum

Published 08th Mar 2008

It is a conundrum facing millions with a mortgage -- to fix or track?

Some 1.4 million borrowers will see their existing fixed rates expire this year, according to the Council of Mortgage Lenders (CML).
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That figure, say others, is in reality far higher -- and could hit something approaching four million when you include people coming to the end of deals like tracker and discounted rates.

Ray Boulger, for example, senior technical manager at independent mortgage broker John Charcol, estimates that 3.6 million people will come to the end of the offer period on their home loan this year.

Rates, although still historically low, are higher now than they were two or three years ago: those coming off cheap fixed-rate deals will be hit with at least 1 percent more.

Homeowners are set for a "rate shock" that will add an average 210 pounds to their monthly mortgage bills if they move onto their lender's standard variable rate (SVR).

"The figure for two-year fixed rates was used primarily to talk about 'payment shock', but there will just as much -- and in some cases more -- payment shock for people coming off a good tracker or discount, and often also for people coming off some longer-term fixed rates," says Boulger.

"For example, in mid-2003 several lenders offered five-year fixed rates below 4 percent."

n reality, of course, few people will revert to their lenders' SVR. They are more likely to refinance onto a new fixed or tracker rate, bringing a much lower level of increase in monthly payments.

The prospect of a lower Bank of England base rate -- already cut twice since December -- is also set to reduce the intensity of payment shock as the year progresses.

Additional mortgage repayments for the one million whose two-year, fixed-rate products mature are expected to fall steadily to just 39 pounds in the fourth quarter of 2008 from 140 pounds in the first three months of the year.
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The prospect of extra mortgage repayments is, adds the CML, more than outweighed by greater earnings. Typical first-time buyers coming off a two-year fix will have a net monthly income 185 pounds higher than when they took out the loan.

"Borrowers' capacity to absorb higher payments is likely to be better than it initially appears," says the trade body in a newsletter.

"Nevertheless, 2008 will be a challenging year for the economy and consumers as the conflicting pressures of inflation and sluggish growth reduce the likelihood of aggressive rate cuts."

The Bank of England has cut the base rate twice since December, taking it to 5.25 percent.

But tracker rates, which are linked to official interest rates, have crept up, as demand for them soars.

A growing band of homeowners are turning to trackers in the expectation that the Bank's Monetary Policy Committee will cut rates further to 5 percent or lower by Summer, but lenders have been taking the opportunity to improve their profit margins.

"The connection between base rate and mortgage rates has been all but severed as a result of the liquidity crisis," says Melanie Bien, a director at independent mortgage broker Savills Private Finance.

"Lenders have been looking to improve margins rather than chase market share, so while fixes have edged down, they have not moved down as quickly as we would normally expect."

There is now little difference between fixed and tracker rates. The best fixes stand at less than 5.5 percent, while trackers (generally priced at just below base rate just three months ago) come in at 0.18 percent or 0.2 percent above base.
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The message from experts is clear: with the best deals being around for a mere matter of weeks before they are pulled, speed is of the essence.

"Some people have been trying to second-guess the market and have come a bit unstuck," says Richard Roberts, a financial consultant at independent wealth manager Route Group.

"A lot of people have been delaying and delaying, because they expected a better deal, but the anticipated drops (in rates) are not happening. Lenders are pulling deals and increasing their rates.

"Action is really going to win the day: pretty much everyone who took out a mortgage in the past two or three years is going to have a big payment shock, whether they're coming off a fixed or tracker rate, and I'd say to them -- do something sooner rather than later."

As lenders are inundated with remortgage businesses and free legal services (that come with many remortgages) creak under the pressure, homeowners should allow eight to 10 weeks for the process to be completed.

But just what type of deal should you opt for -- a fixed rate or one that has the potential to vary?

Firstly, check what your existing lender can offer you.

"With ever-increasing fees on mortgages, especially shorter term deals, it is worth checking to see what your current lender can offer because it will save you paying as much for set-up fees, in particular valuation and legal fees," says Julia Harris, an analyst at price comparison service Moneyfacts.co.uk.
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After that, scour the market for the top deals.

The route you should go down largely depends on your attitude to risk and need for payment security.

Fixed rates give the certainty of set repayments for a given period, while trackers and discounted rates can change.

Trackers follow the Bank of England base rate by a given margin, whereas discounted mortgages can be a discount off a lender's SVR. Beware, though -- your lender might not necessarily follow a reduction in the base rate.

"With a fixed rate you will know exactly how much you will have to set aside each month for your mortgage, which will make it easier to budget," says Paul Chafer, commercial director at Stroud & Swindon.

"If interest rates rise -- and who really knows -- you'll be shielded from any nasty repayment shock as your repayments are fixed.

"However, should the Bank of England continue on its rate-cutting agenda in 2008, you could end up paying over the odds for fixing."

Cumberland Building Society has a two-year fixed rate remortgage at 5.08 percent with a 995 pound fee, which can be added to the loan, and free valuation and legal fees.

Other low-cost fixed rates are currently on offer from Newcastle Building Society (5.25 percent for two years), the Post Office (5.34 percent for three years) and Direct Line (5.49 percent for three years), according to Moneyfacts data.
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Longer-term fixed rates can be more competitive. Abbey has a 10-year fix at 5.64 percent (compared to its two-year fix of 5.79 percent), Halifax has a 10-year fix at 5.69 percent (compared to 5.89 percent over two years), while with Nationwide you can fix for 10 years at 5.88 percent or two at 6.05 percent.

"Not only are initial rates and fees on 10-year deals cheaper than two-year rates, but also the deals may also work out less expensive in the long run," says Moneyfacts' Harris.

"Imagine after every couple of years having to pay another round of set-up fees -- the average at the moment is around 1,000 pounds and still rising -- and that's without factoring exit fees into the equation."

Of course, few people are comfortable with being locked into a product for a decade -- or relish the prospect of paying hefty exit penalties to repay the loan before the end of the term.

For the best of both worlds, penalty-free trackers are a good option.

Lloyds TSB has a two-year tracker at 0.38 percent over base, giving a current pay rate of 5.63 percent. This has a 1,995 pound fee, but comes with free valuation and legals.

Moreover, it is penalty-free, so borrowers could switch to another deal without having to pay an exit fee if rates start to move upwards.

Another option, ideal for those who want to cut out regular remortgage fees, is a lifetime tracker.

Saffron Walden Building Society has one at 0.3 percent over base for the term of the loan, giving a current 5.55 percent.
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There is a 499 pound fee, but free legals and refunded valuation. Penalties apply for the first three years.

By Jennifer Hill. We say: Obtain Professional Advice.

Source: ' Reuters '

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