Long-term fix starts to look more tempting

LOW interest rates have taken some of the gamble out of the decision of whether to opt for a fixed or variable rate mortgage over the past year.

Those taking the wrong option can face potentially costly consequences, but the choice has been made relatively easy by record low interest rates, held this week at 0.5 per cent for the 15th successive month, and few experts predict any change this year.

Now, however, the waters are getting murkier for borrowers without access to a crystal ball. Not only have some of the UK's biggest lenders increased their variable rates in recent weeks, but for borrowers with deposits of 25 per cent or more available, increased competition is steadily reducing the cost of fixed rate mortgages. The cost of the most popular mortgage deals has tumbled to the lowest level on record as a result of increased competition for business, albeit aimed primarily at those with at least a 25 per cent deposit.

The average two-year fixed rate for up to 75 per cent loan-to-value (LTV) fell to a record low of 3.8 per cent last month, according to the Bank of England, compared to 4.47 per cent last September. Five year deals fell to an average of 5.39 per cent, the lowest in a year, while tracker mortgage costs reduced slightly in May to 3.7 per cent, 3.2 percentage points above the base rate. Nationwide, Santander, Yorkshire Building Society and Barclays have all launched new deals in the past week alone, ranging from first-time buyer initiatives to long-term fixed rates.

Meanwhile, 16 lenders have increased the cost of their standard variable rates (SVRs) since the base rate reached 0.5 per cent last March, with no lender reducing its SVR over that time.

Ray Boulger, senior technical manager at broker John Charcol, believes that moving from an SVR to a fixed is a more viable option now than for over two years.

"The cost of fixed rate mortgages has fallen sharply over the last few months, with five-year fixed rates starting around 4 per cent and at the cheapest level since 2003," he said. "The availability and pricing of mortgages at higher LTVs has improved significantly and so even remortgaging with an 85 per cent LTV will be worthwhile for some borrowers."

Boulger, who pointed out that most borrowers can currently move from their SVR without paying an early redemption charge, said anyone on an SVR of 3.5 per cent or higher and with a deposit of at least 15 per cent should consider moving to a fix, provided they have a decent credit record.

But if you do opt for a fix, how long should you tie in for? With uncertaintly lingering around the UK economy amid rising unemployment and the prospect of swingeing spending cuts, the certainty of longer-term mortgage deals is becoming more appealing, believes Andrew Hagger, head of communications at Moneynet.

He said: "Shorter term fixed rate deals have always been the more popular choice but with the new coalition government warning that the next few years are going to be painful, maybe the certainty of payment amount and peace of mind offered by a longer term fixed rate will start to have greater appeal."

The desire for greater long-term certainty was behind the ten-year fixed rate launched yesterday by Yorkshire Building Society. The 4.99 per cent fixed rate not only went straight to the top of the ten-year best-buy table, but undercut the SVR currently offered by more almost 60 per cent of lenders.

Peace of mind aside, longer-term deals mean only having to pay one lending fee, compared with five separate fees if you switch every two years. And that's before costs such as redemption fees, valuation and legal fees.

On the other hand, said Hagger, shorter term fixes and tracker products are currently quite a bit cheaper. "But with many trackers operating on margins of two to three percentage points above base rate, it won't take too many rate rises for the 4.99 per cent figure to be breached."

Based on a 100,000 25-year term mortgage, the Yorkshire ten-year deal would cost 3,346 more over the first five years than the cheapest five-year fixed rate mortgage currently available (3.99 per cent from Co-operative Bank).

Take fees into the equation and the longer term deal looks better … and then it depends on where you expect interest rates to be in five years time. And that's anyone's guess.

Hagger said: "While 10 years may still seem a fix too far for many people, with a competitive sub 5 per cent rate and all the uncertainty surrounding future mortgage funding and the wider UK economy, it will be interesting to see the level of take-up for this product and whether other providers will re-enter the long term mortgage market."