To fix or not to fix, that's still the question for borrowers

Published on 14/08/2009 20:01

INTEREST rates may be stagnant but many borrowers face a dilemma that could save or cost them thousands when the Bank of England eventually acts.

With the base rate at a historical low of 0.5 per cent since March the next movement will only be upwards, a fact that homeowners on their lenders' standard variable rate (SVR) or coming to the end of a fixed rate have to consider when making their move.

For many, the security of a fixed rate deal is offset by the cheap tracker rates still available. But whether you stay on your lender's SVR when your existing deal ends depends largely on individual circumstances, said John Postlethwaite, consultant at Punter Southall Financial Management in Edinburgh.

"If you're on a low SVR, such as the 2.5 per cent Lloyds SVR or the Halifax 3.5 per cent deal, and you can only get a fix at over 5 per cent, why would you opt to double your mortgage? Conversely, if you're on the Bank of Scotland SVR of 4.84 per cent, for example, it is not such an issue."

Currently, borrowers with 40 per cent equity in their home can get a tracker as low as 3.1 per cent or a fixed-rate mortgage from around 3.98 per cent for two years and to 5.6 per cent for five years, said Heidi Poon, director of tax at Morton Fraser in Edinburgh. The arrangement fee for both two and five-year terms is about 1,000.

Last month saw a shift towards trackers, according to Mortgageforce Scotland, which said 37 per cent of its customers opted for a tracker, up from 25 per cent in June.

Katie Tucker, technical manager at the broker, said borrowers' heads had been turned by attractive tracker deals. "Lenders released some storming tracker and discount rates in response to the rush on fixed rates in June, because bank and building societies' own loan sheets have to have a balance between fixed rate customers and variable rate customers."

However, those tracker savings could be short-lived if rates rise sharply. Borrowers with a 150,000 mortgage and on a tracker will see their monthly repayments increase by over 300 if base rate returns to 4 per cent, an increase that could create difficulties for many, said Louise Cuming, head of mortgages at Moneyfacts.

"If the Bank of England raises base rate sharply, those fixing now are likely to be better off in the long run than those locked into variable rate deals."

Consequently, borrowers opting for trackers should choose deals that don't levy early repayment charges (ERCs) so they can switch to a fixed rate when base rates increase. Most lenders levy exit penalties, with the exceptions including Abbey, HSBC and First Direct.

Securing a tracker also involves a fee, usually over 1,000. The Abbey 3.75 per cent tracker has no ERC but it has a 1,500 fee, while the First Direct 3.09 per cent two-year tracker has no ERC but a fee of 999, which is available with a 20 per cent deposit. Where booking or arrangement fees are this high, borrowers will want to ensure that their savings cover the charge.

Some lenders allow borrowers to switch and fix, whereby a tracker mortgage can be converted to a fixed-rate mortgage with the same company, noted Poon. "This may afford the greatest flexibility to a homeowner who is enjoying the lower rate from a tracker mortgage at present, but is prepared to take quick action to jump ship when the signs are changing to fix the mortgage rates before the next move in the base rate."

But she believes that "the certainty of affordability offered by a fixed-rate mortgage has its timely appeal in the current economic environment".

This is why the longer term fixed rates of five years or more are regaining favour among borrowers who recognise that interest rates could rise quickly once they start going up.

"They are looking for longer than two or three years as those deals are likely to be ending when interest rates are high," said Postlethwaite. "On the other hand, a five-year rate will probably see you through the worst of the high rates and you will be coming out when the economy is more stable."

However the supply of long-term fixed rate deals has dried up recently. Fixed rates of ten years or more accounted for 15 per cent of all mortgages in July 2008, but that share has since plummeted to 3.5 per cent, according to MoneyExpert.com.

Pierre Williams, head of research at MoneyExpert.com, said long-term deals had been widely available in the early days of the credit crunch as lenders and borrowers sought certainty.

"But in the past year the full force of the economic downturn has compelled lenders to reappraise their mortgage books," said Williams. "Long-term lending is a thing of the past unless you are a very, very safe bet with a large deposit. Lenders are forcing their customers to take a risk on the unknown direction of future interest rates."