A fix is still the right answer for first time buyers
By Chris Gilchrist    14th August 2007

Some mortgage brokers are advising buyers to go for variable rate mortgages on the basis that interest rates are near a peak. But FTBs really need the security of fixed repayments.

There are two reasons why mortgage brokers will tend to push variable mortgages, one good and one bad. The good one is that right now a 'discounted tracker’ is the cheapest deal you can get in terms of monthly repayments.

For example, you can get a 90% loan from Nationwide with its discounted tracker, paying 'base rate minus 0.27%’ making a current 5.48% for 2 years and paying a £599 arrangement fee. After that the rate reverts to Nationwide’s Standard Variable Rate of 7.24%.

There are a few fixed-rate deals where the rate is a touch lower, for example Skipton with a 5.39% rate for two years, but the arrangement fee here is £1,599. More typical two-year fixes are at 5.5% or above. So on the basis of lowest repayments now, a discounted tracker can be justified as a good recommendation for cash-strapped FTBs.

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Beware the hike to an SVR
But there is also a downside with discounted tracker deals. After the initial two-year period the interest rate reverts to the lender’s Standard Variable Rate or SVR. Most big lenders’ SVRs are now about 2% above base rate, which means 7.75%.

How do you feel about seeing a hike in your mortgage repayments of 30% in two years’ time? In money terms, on a £180,000 capital-and-interest loan that would mean a rise from £1,103 to £1,300 a month. It is borrowers hit by rises of this kind who are responsible for a jump in the number of people in arrears on their mortgages in recent months.

If you query this point, brokers will tell you that in two years’ time, when the initial period ends, you can refinance by switching to a different lender on better terms - another two-year discount tracker deal, for instance. This may be true, but there are three major caveats they may not mention.

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Circumstances change… don’t count your chickens
One is that you need to be at least as creditworthy as you are now, so if you lose or change your job (or your partner does), you may not be able to get as good terms - or indeed any terms - from another lender, which means you would have to stay with the existing lender and pay the higher rate.

Second, it assumes your home will be worth at least as much then as it is now: if it happens to be worth less, you may need a higher loan-to-value, which may involve a higher interest rate or simply not be available. Third, mortgage loan availability depends on the financial markets in general, and if the economy is in recession and lenders are more cautious, their interest rates may be a lot higher then than now.

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be burned by the churn
There is also a bad reason why brokers recommend short-term deals for two years. If you switch mortgages you will incur another arrangement fee. Fees have risen sharply in the past two years and for the best mortgage deals fees are often over £1,500.

A large part of these arrangement fees are paid to mortgage brokers, whose 'free’ advice is paid for out of the fees you pay to the lender. So 'fee-free’ brokers’ financial interests (regular switches to generate fees) do not exactly coincide with your own financial interests.

I don’t mean to imply you won’t get good advice from a broker. On the contrary, I think they can be very helpful in steering you through the morass of jargon and terms to a good deal. But be realistic. Think for yourself about the potential risks.

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vs. variable: the numbers
So let’s weigh up the potential risks and rewards in the fixed-versus-variable debate. I’ll do this in money terms assuming the same £180,000 loan on a £200,000 property, and the figures are based on a repayment (capital-and-interest) loan.

The comparison is between Nationwide’s two-year discounted tracker at 5.48% and Norwich & Peterborough’s five-year fix at 5.99%. The arrangement fee is the same at £599.

So for the first two years the figures are:

	Monthly repayment	2-year total
Discounted tracker	£1,103.21	£26,477
Fixed	£1,158.64	£27,807

For the next three years, assuming you pay Nationwide’s SVR at its current 7.24%, the figures are:

	Monthly repayment	3-year total
Tracker	£1,230	£44,280
Fixed	£1,158.64	£42,711

Over the whole 5 years, the costs are Tracker: £70,757 Fixed: £70,518

There really isn’t a lot of difference (ignoring an extra arrangement fee after two years for the tracker). But this assumes interest rates remain at their current level, which is most unlikely. So the next question is, how much could you win or lose if interest rates change?

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What are the risks?
There are innumerable scenarios but let’s start with what may seem the most plausible. The consensus economists’ view is that interest rates are near a peak, that Base Rate will rise to 6% this autumn and then fall from sometime next year.

In this case, you’d pay a little more with your discounted tracker: your repayments would rise in line with Base Rate, so a quarter-percent rise in base rate to 6% would mean repayments going up to £1,130 a month. Over the following two years, it’s unlikely Base Rate will fall below 5%, so lower and higher repayments could balance each other out.

But economists’ forecasts have rarely come to pass. Their record of predicting interest rates is abysmally bad. And the right question for a mortgage borrower isn’t what experts predict but this one: “What’s the worst that could happen?”

In this case, the answer is not difficult: inflation stays stubbornly high, so the Bank of England has no option but to keep on raising interest rates, which reach 7% next year and then only come down slowly over the next three years. That implies SVRs at 9% and mortgage repayments of £1,500 a month.

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Stay safe with fixed
In this case, you’d end up paying a lot more with the variable interest mortgage than the fixed rate one. If you could afford it, that is. And that’s really the point: if you really can’t afford to pay more, then the fixed rate loan is the right answer, whether or not you’re a FTB.

As and when it is clear - as evidenced by statements to that effect from the Bank of England - that inflation is under control, which means interest rates are likely to fall, then the risk-reward equation will change and it will be worth considering variable rate loans. Until then, my view is that fixed rate loans with terms of five to ten years are the best choice for almost all mortgage borrowers.

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Article produced by EveryInvestor.co.uk