Should you fix your mortgage?
Whether you are looking to buy a property or need to remortgage, the question on everybody’s lips is whether tracker mortgages are still worthwhile or if now might be the time to fix.
The Bank of England’s dramatic base rate cuts between October last year and March prompted a surge in the popularity of tracker-rate mortgages, as borrowers chased the opportunity to pay as little as 0.1% on their loans. However, the central bank’s Monetary Policy Committee (MPC) has held the base rate at 0.5% since then, and it is extremely unlikely that it will fall any further.
The jury is still out as to how long the MPC will keep the base rate at 0.5% before this rises again to a more 'normal' level. Much depends on the outlook for inflation; if this increases sharply as a result of quantitative easing measures and the spike in oil costs, then the central bank could respond by raising rates.
However, if the British economy remains weak and shows little sign of improvement, then the base rate may well be kept at its current level (or, at least, at a low level) to help encourage a recovery.
But what does this mean for mortgage borrowers? Is it still worth opting for a tracker-rate mortgage and enjoying the historically low base rate while you can - or should you fix now to avoid suffering when the interest rate finally does increase?
According to research from Abbey, demand for variable mortgage products has almost halved since the start of the year. In May, 73% of those questioned believed that the base rate had bottomed, renewing appetite for homeowners to secure a fixed rate.
Nici Audhlam-Gardiner, director of mortgages at Abbey, says: "Fixed rates are firmly back on the agenda for those looking to remortgage. As mortgage borrowers realise that variable deals will no longer fall further, it seems that many are now trying to work out when rates will rise again and how long to fix their rate for.”
During the first three months of the year, when the base rate was still falling, fixed-rate mortgages looked expensive compared to their variable counterparts and mortgage brokers forecast they would fall in price going forward.
However, the cost of fixed-rate mortgages are now “off the floor”, according to Ray Boulger, senior technical adviser at John Charcol mortgage brokers, meaning they are now unlikely to get any cheaper. “We’ve probably already seen the cheapest fixed deals we are going to, and borrowers are now looking at paying a premium of 1% above the cost of a lender’s funding until the economy improves,” he adds.
Whether you should fix now, or continue to enjoy a cheaper tracker rate for a while, depends on your circumstances and your outlook for the base rate, says Boulger.
He believes that if you have at least 40% equity in your home (meaning your mortgage’s loan to value ratio, or LTV, is 60%) then it might be worth taking a gamble and sticking with a tracker or your lender’s standard variable rate (SVR). However, there are two risks associated with doing this.
First of all, you need to be on the ball. If the base rate does rise and you are still tracking it then it will probably be too late to bag a fixed-rate bargain, as lenders will have already upped their rates in anticipation. However, David Hollingworth, spokesman for London & Country mortgage brokers, points out the savings you make while the base rate is low might offset the higher cost of a fixed down the line. There is no guarantee over base and mortgage rate movement, however, so this is a gamble.
Another downside is that, if your property falls in value, you could be pushed onto a higher LTV band – generally speaking, the best mortgage rates are reserved for people looking to borrow 60% and anyone with less than 10% equity or deposit might struggle to find a deal.
“One way to avoid this is to overpay on your mortgage while your rate is low,” says Hollingworth. “Again, this might not be enough but it makes sense to use the opportunity of low interest rates to try and reduce your mortgage debt.”
New buyers, however, are probably best off fixing now rather than risking taking a tracker for a couple of years, says Boulger.
Hollingworth agrees: “Opting for a tracker-rate mortgage could see your monthly repayments increase in response to base rate rises in the future. If you can afford this, then you might be attracted to trackers but stress-test your budget first – if you can’t afford higher payments then fixing now is probably your best bet.”
So, whether you’re remortgaging because your previous mortgage’s discount period has ended, moving house or buying for the first time, how long should you fix for?
Again, it depends on your outlook for the base rate. This is impossible to call, but predictions from the Bank of England suggest it could remain low (below 2%) for a couple of years.
For Boulger, this means that there is little point in opting for a two-year fixed rate. Instead, he suggests people look at five and seven-year deals. “You’ll pay more for the first couple of years with a longer-term fixed-rate but this approach has the potential to be cheaper down the line,” he explains.
Elsewhere, HSBC offers a five-year fix at 4.39% up to 75% LTV with a £999 fee and free legals.
If you borrowed £100,000 from Marsden rather than HSBC then you would save 1% - or £2,000 – for the two-year period. “But there is no guarantee how much more you face paying after two years,” says Boulger. “It’s a dangerous game to play.”
Of course, the downside of fixing for five or seven years (or longer) is that your circumstances might change during that time. While most mortgages are portable, meaning you can move them from one property to another, this isn’t as easy as it sounds.
For example, if you are planning on moving up the ladder but don’t have money to hand to pay for this, you run the risk of your lender refusing your request for a further advance. Equally, changes to your employment or credit history could leave you stuck.
“If you decide you’re better off redeeming your mortgage early, then chances are you’ll have to pay an early repayment charge, which is typically 3% of the money borrowed,” says Hollingworth.
Changing mortgages without moving home. Property owners chiefly remortgage to get a better deal but some do so to release equity in their homes or to finance home improvements, the costs of which are added to the new mortgage. Even though you’re not moving house, you still need to engage solicitors, conveyancing and the new lender will require the property to be surveyed and valued.
Every mortgage lender has a standard variable rate of interest, or SVR, on which it bases all its mortgage deals, including fixed and discounted rate and tracker mortgages. When special deals come to an end, the terms of the deal usually state that the borrower has to pay the lender’s SVR for a period of time or pay redemption penalties. The lender’s SVR is, in turn, based on the Bank of England’s base lending rate decided by the Bank’s Monetary Policy Committee (MPC). Every time the MPC raises its rate, mortgage lenders generally increase their SVR by the same amount but when the MPC lowers its rate, lenders are often slow to pass this on or don’t pass on the full cut to borrowers.
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Loan to value
The LTV shows how much of a property is being financed and is also a way to tell how much equity you have in a property. The higher the LTV ratio the greater the risk for the lender, so borrowers with small deposits or not much equity in the property will be charged higher interest rates than borrowers with large deposits. The LTV ratio is calculated by dividing the loan value by the property value and then multiplying by 100. For example, a £140,000 loan on a £200,000 property is a LTV of 70%.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.