Home owners worried about imminent interest rate rises should not be panicked into switching to a fixed-rate mortgage. Pressure is building for a rise in interest rates, despite the decision by the Bank of England to keep rates on hold last week. But worried home owners are being urged to hold their nerve, rather than turning to the security of a fixed-rate mortgage. The Bank Rate has now stood at a historic low of just 0.5pc for two years, but, with inflation running at more than twice the Government's target, there are fears that the Bank of England could be forced to push interest rates up soon.
The usual advice for those concerned about rate rises is to opt for a fixed-rate deal – so you know exactly what your monthly mortgage payments will be.
But the clamour for fixed-rate products has meant that many banks and building societies have increased the margins on these deals, so home owners are now paying a hefty price – in most cases two full percentage points – for the peace of mind they offer.
Ray Boulger of John Charcol, the mortgage broker, said: "Realistically, most people who want to fix their mortgage will be looking at a five-year deal. There seems little point in two-year fixes at present. If you are worried about future rate rises then we are still likely to be in this situation when these deals end, and you could find yourself remortgaging again in the eye of the storm."
But those who want to take a five-year fix may be shocked to find out just how expensive they are. The cost of these deals has risen by a full percentage point in just the past three months. The cheapest five-year fixed rate currently available is from HSBC. It charges 4.39pc and is available only to those with at least 40pc equity in their home. They will also pay a £999 fee to secure the deal. Those with less equity will pay substantially more: if you're borrowing more than 75pc of your property's value the best rates will be closer to 6pc.
In comparison, low-cost tracker mortgages have become cheaper recently. According to Moneyfacts, the financial data provider, the average cost of a two-year tracker is now at its lowest level ever.
The initial savings are substantial. HSBC, for example, charges an initial rate of just 2.29pc on its lifetime tracker mortgage (Bank Rate plus 1.79 percentage points). Again, customers need 40pc equity, but the fee is just £99, and there are no redemption penalties.
Monthly mortgage payments (assuming you have a £150,000 interest-only mortgage) are £286 on the tracker deal, compared with £549 a month on the five-year fix. For the same 25-year mortgage on a repayment basis you would pay £662 for the tracker and £833 for the fix.
Mr Boulger added: "People might have missed the boat on five-year fixes, at least for the time being. Tracker rates are looking more attractive, with significant savings at present, particularly for those with relatively large loans."
But the big question is whether these tracker deals will prove to be better value over the longer term.
This, of course, all depends on what happens to interest rates in the interim. Melanie Bien, a director of Private Finance, the mortgage broker, said: "Given the differential in pricing, interest rates would have to rise by quite some margin before you would be better off on the fixed-rate deal."
If your mortgage rate is currently 2.5pc (which is the standard variable rate charged by Nationwide and C & G, for example), there would need to be nine quarter-point increases in the Bank Rate before your monthly mortgage payments exceeded what you would be paying on a five-year fix.
To put it another way, interest rates would have to average 2.5pc over the next five years for the fixed-rate deal to be better value than the tracker – at current pricing levels.
Economists agree that interest rates will almost certainly rise this year and will eventually head back towards a more "normal" level, probably about 5pc. But what they don't agree about is how quickly this will happen. If rates don't start to rise until much later this year, and then notch up slowly, then people are effectively "overpaying" on a fixed rate, which means it's unlikely to offer such good value over the long term.
Mr Boulger said: "Inflation may be putting pressure on the Bank of England to increase rates. But the Bank also has a remit to facilitate growth in the economy. The weak growth figures we have seen mean there are still concerns about a double-dip recession.
"We know there is going to be a bigger squeeze on consumers this year, with tax and National Insurance rises, plus the increase in oil prices. This will impact on consumer confidence and further dampen spending. This is likely to mean any rate rises we see this year will be very modest."
He added that, given the problems in the banking sector, recovery was likely to be a slow process, which might also delay significant rate increases.
Mark Harris, a director of Savills Private Finance, another broker, said: "For many people I think it still makes sense to hold your nerve and sit tight. But – and it is a big but – this only applies if you can afford to get the gamble wrong. Second guessing interest rate movements is a dangerous game. If you get it wrong, and can't afford the subsequent mortgage payments, then you stand to lose your home. If you need the security of a fix then it is worth paying for."
1. Overpay your mortgage: Those enjoying the benefits of a low variable rate deal should be looking to make overpayments now while they can afford it.
2. For those on repayment mortgages, this ensures that more of the capital is paid off, so reducing the overall cost of the mortgage. It also means you get used to paying a higher monthly sum, so rate rises aren't so much of a shock to the system.
3. "Drop and lock" deals: These offer a cheaper variable rate with the option of moving to a fixed rate at a later date for no extra charge. Don't assume you'll get the current fixed deal though. You'll be offered whatever rates the bank is marketing at the time – which could be substantially higher once interest rates start to rise.
However, there are some specialist products that offer more certainty. Savills is offering a hybrid tracker fix, offering a two-year variable rate of Bank Rate plus 1.79 percentage points (giving a starting rate of 2.29pc). This is followed by a three-year fix at 4.74pc. It comes with a £1,900 fee.
4. Make savings: This isn't quite as efficient as paying off your mortgage, as you are not reducing your home loan, but it does offer some home owners more flexibility, particularly if they are worried about job security and want to build up some readily available cash reserves.
These reserves can build a cushion to help pay for future mortgage increases. Again, it can help with budgeting, as you get used to a greater slice of your salary disappearing each month.
5. Wait and see: The case for fixing your mortgage may look more attractive at a later date, either because the price of fixed-rate deals falls or – more likely – because steeper rate rises look more imminent.
Make sure you are in a deal without penalties, so you can switch quickly should you need to do so. Remember though that the market is likely to price in such rate rises in advance, pushing the cost of fixed-rate deals up again.
In comparison, low-cost tracker mortgages have become cheaper recently. According to Moneyfacts, the financial data provider, the average cost of a two-year tracker is now at its lowest level ever.
The initial savings are substantial. HSBC, for example, charges an initial rate of just 2.29pc on its lifetime tracker mortgage (Bank Rate plus 1.79 percentage points). Again, customers need 40pc equity, but the fee is just £99, and there are no redemption penalties.
Monthly mortgage payments (assuming you have a £150,000 interest-only mortgage) are £286 on the tracker deal, compared with £549 a month on the five-year fix. For the same 25-year mortgage on a repayment basis you would pay £662 for the tracker and £833 for the fix.
Mr Boulger added: "People might have missed the boat on five-year fixes, at least for the time being. Tracker rates are looking more attractive, with significant savings at present, particularly for those with relatively large loans."
But the big question is whether these tracker deals will prove to be better value over the longer term.
This, of course, all depends on what happens to interest rates in the interim. Melanie Bien, a director of Private Finance, the mortgage broker, said: "Given the differential in pricing, interest rates would have to rise by quite some margin before you would be better off on the fixed-rate deal."
If your mortgage rate is currently 2.5pc (which is the standard variable rate charged by Nationwide and C & G, for example), there would need to be nine quarter-point increases in the Bank Rate before your monthly mortgage payments exceeded what you would be paying on a five-year fix.
To put it another way, interest rates would have to average 2.5pc over the next five years for the fixed-rate deal to be better value than the tracker – at current pricing levels.
Economists agree that interest rates will almost certainly rise this year and will eventually head back towards a more "normal" level, probably about 5pc. But what they don't agree about is how quickly this will happen. If rates don't start to rise until much later this year, and then notch up slowly, then people are effectively "overpaying" on a fixed rate, which means it's unlikely to offer such good value over the long term.
Mr Boulger said: "Inflation may be putting pressure on the Bank of England to increase rates. But the Bank also has a remit to facilitate growth in the economy. The weak growth figures we have seen mean there are still concerns about a double-dip recession.
"We know there is going to be a bigger squeeze on consumers this year, with tax and National Insurance rises, plus the increase in oil prices. This will impact on consumer confidence and further dampen spending. This is likely to mean any rate rises we see this year will be very modest."
He added that, given the problems in the banking sector, recovery was likely to be a slow process, which might also delay significant rate increases.
Mark Harris, a director of Savills Private Finance, another broker, said: "For many people I think it still makes sense to hold your nerve and sit tight. But – and it is a big but – this only applies if you can afford to get the gamble wrong. Second guessing interest rate movements is a dangerous game. If you get it wrong, and can't afford the subsequent mortgage payments, then you stand to lose your home. If you need the security of a fix then it is worth paying for."
Have your cake and eat it?
For those who are concerned about rate rises, but don't want to pay the full premium of a fixed rate, there are a number of options.1. Overpay your mortgage: Those enjoying the benefits of a low variable rate deal should be looking to make overpayments now while they can afford it.
2. For those on repayment mortgages, this ensures that more of the capital is paid off, so reducing the overall cost of the mortgage. It also means you get used to paying a higher monthly sum, so rate rises aren't so much of a shock to the system.
3. "Drop and lock" deals: These offer a cheaper variable rate with the option of moving to a fixed rate at a later date for no extra charge. Don't assume you'll get the current fixed deal though. You'll be offered whatever rates the bank is marketing at the time – which could be substantially higher once interest rates start to rise.
However, there are some specialist products that offer more certainty. Savills is offering a hybrid tracker fix, offering a two-year variable rate of Bank Rate plus 1.79 percentage points (giving a starting rate of 2.29pc). This is followed by a three-year fix at 4.74pc. It comes with a £1,900 fee.
4. Make savings: This isn't quite as efficient as paying off your mortgage, as you are not reducing your home loan, but it does offer some home owners more flexibility, particularly if they are worried about job security and want to build up some readily available cash reserves.
These reserves can build a cushion to help pay for future mortgage increases. Again, it can help with budgeting, as you get used to a greater slice of your salary disappearing each month.
5. Wait and see: The case for fixing your mortgage may look more attractive at a later date, either because the price of fixed-rate deals falls or – more likely – because steeper rate rises look more imminent.
Make sure you are in a deal without penalties, so you can switch quickly should you need to do so. Remember though that the market is likely to price in such rate rises in advance, pushing the cost of fixed-rate deals up again.
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