Fix now to beat the risk of future mortgage misery
By Chris Gilchrist    6th July 2007

If you’ve got to refinance a mortgage now, don’t be tempted to save with a variable rate deal - it could end up costing you more. Fixed rates still make sense.

Some economists think that interest rates will rise by one more quarter-point to 6% and then start to fall. But if you had planned your life according to these same economists’ forecasts you would already be ruined.

Independent surveys have consistently shown that economists’ forecasts of interest rates are no better than you would get from tossing coin. You might as well trust a tea-leaf reader.

Forget what people are forecasting. Let’s just focus on the numbers.

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Variable versus fixed - the facts
You can get a two-year discounted tracker mortgage from Alliance & Leicester and pay 5.44% for the next two years, along with an upfront fee of £399. After that the rate will be 6.75% assuming that base rate is still 5.75% at that time.
Or you can get a five-year fixed rate from Britannia at 5.69% and pay a £399 fee.

I’ve used these deals because they’re about the best available at present. But there are plenty of others at very similar rates and the comparisons would be much the same.

Assuming a mortgage of £100,000, here is the cost comparison for the first two years:

	A&L tracker	Britannia fixed
Arrangement fee	£599	£399
Interest for two years	£10,880	£11,380
Total	£11,479	£11,779

Overall, the A&L tracker comes in at £300 cheaper.

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The unknown
But what then? The A&L tracker is priced at 1% over base, so if base rate is still 5.75% in two years time the mortgage rate will rise to 6.75%. As I said, economists’ predictions of interest rates are worse than useless, so it makes sense to adopt the weather forecast principle - you are most likely to be right about tomorrow’s weather if you say it will be like today’s. So we’ll assume that base rate is still 5.75% in two years’ time.

On that basis, let’s now compare the costs of the two mortgages for the following three years. The annual interest on the Britannia loan will be £5,690, making £17,070 over three years. The A&L tracker interest will be £6,750, making a total of £20,250. The A&L deal will cost £3,180 more.

Now you can hope to avoid this scenario in one of two ways:
• Base rate will fall, reducing the cost of the A&L mortgage
• You re-mortgage again when the A&L deal comes to an end.

For the annual cost of the A&L tracker to come out at the same as Britannia’s, base rate would have to fall to 4.75% in two years’ time.

If you re-mortgage again in two years’ time, then even if base rate remains at 5.75%, you may be able to obtain another discount offer at a similar rate of 5.5%.

Compare the best of fixed and variable rates with our best buys

Fix avoids the risks
But let’s consider the downside in each of those propositions. First, we have no means of knowing whether base rate will be lower in two years. It might be higher. Unfounded optimism isn’t a good basis for a decision that could cost you £1,000 a year.

Second, the availability of attractive re-mortgage deals owes a lot to bankers’ permissive lending attitudes and their determination to lend for market share rather than profit. Even if a good deal is available in two years, there will be an arrangement fee and it might be a lot more than £599 - in fact, for many of today’s best deals, arrangement fees are over £800.

So if you take a two-year discount deal, then whether base rate rises or stays the same, if you have to re-mortgage again in two years you risk having to pay more for your loan. In fact, the only way you can be worse off with the fixed rate loan is if base rate falls to 4.75% in two years’ time and then stays low.

That means that overall, the risks are lower with the fixed rate loan and I therefore recommend anyone re-mortgaging now to go for a five-year fix. This is a good time to do it since 5-year rates are actually slightly below those for a two-year term.

Article produced by EveryInvestor.co.uk