Why mortgage security could be worth paying for
By Damian Clarkson 23rd October 2007
Variable rate mortgage costs look set to tumble next year, yet a recent survey found that 80% of homeowners would opt for a fixed rate deal when re-mortgaging.
So is there method in their madness, or are they committing financial suicide? Considering the base rate is widely predicted to fall 0.5% in 2008, you could be tempted to say it was the latter.
But dig a little deeper and a very different picture starts to emerge.
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The short term scenario
Let's say you were in the market for a £100,000 two-year tracker mortgage.
Direct Line offers one of the best current deals with a 5.47% rate (reverting to 7.25% thereafter) and a £599 fee.
After two years your total cost, factoring in the anticipated 0.5% base rate cut, will be £14,817. Had you opted instead for a five year fix from
Britannia Building Society at 5.64% with a £999 fee, your total cost would be £15,938 – a significant £1,117 difference.
So the tracker looks like your best bet, and indeed in this isolated example it is. But of course there are so many other external factors to include, and this is where it gets interesting.
Based on a £100,000 mortgage over 25 years
The bigger picture
The most important thing to note is that the UK economy is going through a sluggish period, and the effects of that are already being seen in the mortgage industry.
Lenders have pulled a massive 40% of their mortgage products in the last three months alone. Admittedly most of those have been higher risk offerings, but it shows that lenders are no longer as bullish about the growth prospects in the lending market.
Whatever the reason, these stagnant conditions look likely to mean less choice for customers, who may begin to find that the most competitive deals are harder to track down.
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End of fast and loose lending
Scarcer deals are just the start of homeowners' worries, as even if they do manage to find the best deal for them going forward, it's becoming increasingly likely they won't qualify for it.
A recent survey found that the number of people who have had mortgage applications turned down has increased 60% during the past six months.
That's because lenders have become decidedly jittery about who they take on as customers in the wake of the Northern Rock fiasco coupled with the US sub prime meltdown.
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Not just the economy that changes
You also need to keep in mind that your own financial situation could change in that time. For example, if you lose or change your job, your creditworthiness will change and you may not be able to get as good terms from another lender.
The value of your home is another important factor, as any devaluation may mean you're forced to take out a higher loan-to-value mortgage, which in turn could mean higher interest rates.
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Things could get far worse
With all this in mind, it's entirely possible that homeowners who opt for a short term deal now will be forced to settle for a far less competitive deal when it comes to re-mortgaging in two years' time (languishing on your lender standard variable rate instead would be a fast track to financial disaster).
And once you factor in the additional arrangement fee to be paid, it could be that a five-year fixed deal will leave you in a far better financial position in the long term.
But as I don't have a crystal ball (if I did I'd be off down the races), this is obviously speculation. The only thing that has been consistent in the mortgage industry in recent months has been its inconsistency.
No one really knows what it will be like in two months, let alone two years, which brings us to the main reason why so many people opt for fixed rate deals.
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Always prepare for the worst
Knowing that the cost of your mortgage repayments won't change for a number of years is an attractive proposition for any homeowner. But for those who still have a large debt it's nothing short of essential, as even slight fluctuations can have a massive impact.
Put simply, you can't take a risk on prices falling if you can't afford it should the base rate head in the opposite direction (it's worth repeating that this market is nothing if not unpredictable). That's why so many people are resisting the lure of short term financial gain with a tracker for the long-term peace of mind of a fixed rare deal.
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Can you get the best of both worlds?
But homeowners may not have to sacrifice one to achieve the other, following the launch of two products that offer the chance to take a tracker rate, but then switch to a fix without incurring early repayment charges (ERCs) if rates start to rise.
Lloyds TSB has launched its ‘Track & Lock' deal that tracks the Bank of England base rate for five years - the rates start at 0.24% over Base, currently 5.99%, with a £398 fee.
Alternately, Woolwich has launched a stepped tracker with an initial rate of 0.26% below Base Rate in year 1, currently 5.49%, followed by 0.39% above base. The deal has ERCs for the first 3 years.
“The rates on both these deals are pretty good, but borrowers should also consider what's on offer if they decide on either a fix or a variable,” warns L&C mortgage specialist James Cotton. “If you need the security of a fix, it is best to take it now and not gamble - after all if you wait until a rate rise to switch, fixed rates could already have become more expensive.”
You should also keep in mind that if you take up the option to switch to a fix, you will only have access to that specific lender's fixed rates, which may not be the best available at the time. In both cases, you will have to pay a new arrangement fee where applicable - Woolwich also charges a £100 rate switch fee on some deals.
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Article produced by EveryInvestor.co.uk
