Is it time to fix your mortgage rate?
Back when the property market was booming and the prospect of an economic crisis seemed about as likely as England winning the 2010 World Cup, fixed rate mortgages were firmly in fashion.
Fixed rate deals offer borrowers the security of knowing what their monthly mortgage payments will be for a set period of time, because the rate of interest charged is locked at the level on offer when the home loan is first taken out.
As the credit crunch began to bite, however, some people argued the smart money was on tracker mortgages. These deals, traditionally viewed as more risky for borrowers, charge a rate of interest that is tied to the Bank of England base rate. This means a borrower’s monthly payments are variable, and – according to what the Monetary Policy Committee (MPC) decides – the cost of a tracker mortgage can suddenly increase or decrease.
Predictions that the MPC would slash the base rate to try and offset the effects of the economic downturn made tracker deals unusually tempting. And after six consecutive base rate cuts, borrowers who took out trackers before Bank Rate began to nose-dive are benefiting from incredibly low mortgage rates.
For example, some Cheltenham & Gloucester borrowers who took out trackers in July 2007 are now enjoying interest free mortgages! This is because, under the terms of their deals, the rate of interest they pay must be 1.01% below the Bank of England base rate.
The trouble with trackers
Unfortunately, the last thing financial institutions need during these troubled times is to be doling out 0% mortgage deals.
As a result, lenders have withdrawn their old tracker products and have begun to price new ones in line with the ever-diminishing base rate.
The tracker mortgages now on the market carry interest rates above the Bank of England base rate. In other words, the amount borrowers are charged for their mortgage will be the base rate plus a certain margin; for example, 2.5%.
Right now, deals like these look enticingly cheap. Opting for a tracker with a 2.5% margin would result in a mortgage rate of 3% – unimaginable a few years ago.
However, a tracker with a ‘margin’ of 2.5% above base could become costly should the Bank of England begin to increase the base rate. If it went up to 6%, a customer with a deal like the one above would be expected to cough up a hefty 8.5% interest on their home loan.
Crucially, it’s likely that the base rate will increase from its record low of 0.5% over the next few years. No one knows when this will happen – but it seems certain that, in the long term, the only way for rates is up.
Getting into a fix
On the other hand, there has recently been a resurgence of affordable-looking fixed rate deals. Depending on the size of your deposit, you could get a mortgage with a fixed rate below 4%, or even 3%.
While many of the fixed rate deals on the market look more expensive than the cheapest trackers, it is worth comparing deals closely before making a decision. It’s a good idea to work out how much base rate would have to rise by in order for any tracker mortgage you’re looking at to reach the same price, or exceed the cost, of a comparatively priced fix.
For example, Matt Andrews, Managing Director of whole of market mortgage broker Money Workout, says: “If we look at First Direct’s tracker, which has a margin of +2.39% above base rate, and compare this with its two year fixed rate deal at 2.99%, it’s clear that base rate would only need to increase by 0.25% for a borrower to be out of pocket by choosing the tracker.”
The unusual appeal of the SVR
Finally, if you are sitting on your lender’s Standard Variable Rate (SVR), now could be the time to consider choosing a new mortgage deal.
A lender’s SVR is – as its name would suggest – the standard mortgage rate that a bank or building society offers. Usually, when the promotional period at the start of your mortgage deal ends, your home loan will be shifted to this rate.
Historically, SVRs have been very uncompetitive in comparison with the best deals on the market. However, thanks to the Bank of England’s progressive pruning of the base rate, some lenders’ SVRs have begun to feel more affordable.
This has led some borrowers to stay on the SVR long after their mortgage deal has expired – perhaps in the hope that further cuts to Bank Rate might force the cost of new deals down.
In my view, this is a risky strategy. With base rate now almost as low as it could go, I think lenders are unlikely to reduce their rates much further.
In addition, it’s crucial to remember that property prices are still on the slide. You may find that the longer you wait to remortgage, the less equity you have in your home – and you could find it incredibly difficult, and expensive, to remortgage in this situation.
The right decision
I believe tracker mortgages’ day in the sun is probably drawing to its close. With some fixed rate deals only slightly more expensive than a new tracker – and with interest rates set to rise again in the medium to long term – it might not be long before today’s fixed rate deals become tomorrow’s cheaper choice.
Of course, homeowners will have to make their mortgage choices in the here and now. The key things to consider are what you can afford, how much you’d value the security of fixing your payments and how you think you’d cope if interest rates began to climb again.
A fixed rate deal will not be right for everyone, and it might cost you more in the short term than a market leading tracker.
However, in the current climate, I think many people will be prepared to pay a little more for the peace of mind an affordable fixed rate mortgage offers.
**This material is for information purposes only and should not be considered financial advice. We strongly encourage our readers not to rely solely on this content, but to seek independent advice when making financial decisions.**
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