Ray Boulger is senior technical manager at Charcol
The fixed rate market has been factoring in an increase in the base rate for some months now, with the trend in fixed rate pricing having been upward since July.
The minutes of the Monetary Policy Committee's meeting in October revealed that four out of nine members voted in favour of a 0.25% increase in the base rate, adding further fuel to the fire. Consequently many lenders have increased their fixed rates or even withdrawn them altogether. There are indications from the City's interest rate futures contact that punters in the City expect base rate to be 5.25% by the end of next year.
We now have the widest gap between market leading fixes and discounts/trackers for some considerable time. Fixed rates for five years and over are discounting an increase in the base rate to such an extent that it would have to rise by over 1.5% to at least 5% before pay rates on the best discount and tracker mortgages excees those on the fixed rates.
This presents a dilemma for anyone who wants or needs the protection of a longer term fixed rate. Taking a fix for five years or longer means effectively locking into the higher projected rates, which may not happen, and if they do will probably fall back during the next five years. However, even today's fixed rates will provide protection against rates increasing above this. And of course the further one tries to forecast ahead the more difficult it becomes.
One obvious solution in theory is a capped rate, but most of the few on offer are unlikely to see their pay rates fall below the cap. One exception is Bristol & West's capped tracker to 31/1/08, which has a cap of 5.19% and an underlying rate of bank base rate + 0.99%, giving a current pay rate of 4.49%. Another option could be a penalty-free fix or cap, but again few of these are available.
Penalty-free discounts and trackers which have a droplock option provide a get out of jail free card for any borrower concerned about future interest rate movements but who nevertheless is understandably reluctant to lock into an uncompetitive fix. The ability to either drop into a new business fixed rate from their existing lender or remortgage penalty free at any time is a powerful tool.
One solution I currently favour is for borrowers to take a flexible discount or tracker, of which there are a good selection under 3.5%, and to make overpayments. If they do so on the basis of, say, a 5% pay rate, as long as their actual pay rate stays below 5% they will be overpaying and building up a reserve from which to make underpayments if necessary in the future. If rates don't increase above this level the mortgage will be paid off more quickly.
Anyone who can't afford their mortgage at a rate of at least 5% probably shouldn't buy the property.
Andrew Frankish is technical director at Mortgage Talk
The money markets are already responding to the possibility of a rate increase by raising their longer term base rate figures and inter-bank rates.
What's more, nearly all the mainstream lenders have withdrawn their fixed rate products over the past few weeks and replaced them with higher rate products. Borrowers looking for security should think about switching to a fixed rate sooner rather than later.
We have probably already seen the lowest fixed rates, especially for longer term schemes up to five years. Nevertheless, the current popularity of fixed rates will continue, even though a base rate increase will almost certainly mean more expensive fixed rates in the near future. However, some lenders have been known to launch competitive fixed rate products simply to encourage customers in.
Over the next 12 months, we are likely to see penalty-free mortgage products phased out, with the reintroduction of more extended tie-in schemes on the lowest rates. Fixed rate products may increase by the odd percentage point, which suggests that now is a good time for people to get into the better fixed rate offers.
If interest rates do rise a little in the short to mediumterm, fixed rates will still be higher than the better discounted schemes. Nevertheless, fixed rates give certainty and security, though if rates remain constant discounted products are still better value.
For example, if we take an average three-year fixed rate at 4.5% and compare this with a three-year discounted scheme at 3.9% it could still be more cost-effective for a borrower on a tight budget to go for the discounted scheme. However, depending on how interest rates move during the incentive period, the discounted product could be a gamble.
In addition, fixed rates usually carry higher upfront costs such as booking and arrangement fees. If these are, say, £300 borrowers should calculate how much cheaper the fixed rate deal would have to be for them to save on monthly repayments. If it costs an additional £300 to join a fixed rate scheme, but you are only saving £10 per month, it might not be worth sacrificing a more attractive discounted rate.
Extended tie-ins are more common with fixed rate schemes. In addition, if the borrower wants to leave the scheme during the tie-in period the penalties are often higher. Borrowers should also check whether the product is portable and, if so, whether this applies to the full amount they are looking to borrow.
As fixed rates have recently increased without a corresponding move in the bank base rate, this implies lenders miscalculated. However, potential borrowers should continue to hunt for bargains as lenders may bring out unusual products to bring in business.
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