Should you lock in to a cheaper mortgage?

Posted on: 12 May 2009 by Gareth Hargreaves

Most experts believe fixed rates will rise soon. So is now a good time to lock in to a cheaper mortgage?

A glimmer of positive news has emerged for homeowners with reports that house sales were up by 40% in March compared with the previous month.

According to Nationwide Building Society, property prices, which have slid 20% from their 2007 high, could also be stabilising. But problems remain. For borrowers with little or no equity, and for those hoping to buy for the first time, it is still difficult to get a mortgage.

This is despite Government initiatives in last month's Budget and measures to increase funding.

On the other hand, millions of borrowers with variable deals, or mortgages that track the plunging Bank of England base rate, have seen their monthly costs fall dramatically. Unfortunately they have to face the increasing likelihood that mortgage rates will start to rise.

Should I Fix My Mortgage Rate Now?

Most experts believe that fixed rates will rise soon. With two-year rates at less than 3% and five-year deals at about 4% for borrowers with a big slice of equity - typically 60 to 75% for the most competitive deals - now could be a good time to grab a bargain.

Arieh Zucker of mortgage broker Windfall Finance in Horsham, West Sussex, says: “Borrowers are enjoying their low tracker or standard variable rate (SVR) mortgages, but they could come to regret their complacency in the not too distant future.

“Fixed rates may not look so hot in comparison, but it is unlikely they will fall much lower and borrowers stand to lose if they wait too long to act. If property prices continue to slump, borrowers are only making their position weaker for when the time comes to remortgage. This could turn to panic if interest rates suddenly spike up, as happened in the last recession.”

Richard Morea of broker London & Country Mortgages in Bath, Somerset, says fixing for a longer term could pay dividends.

“The difference between two and five-year fixed rates is small,” he says.

“Borrowers who are comfortable locking into a rate for longer should look at five and even ten-year fixes. Most mortgages are portable so it shouldn't restrict you if you need to move house. A long-term fix provides stability at a time when interest rate changes could be volatile and extreme.”

It is possible to reserve most mortgage deals, typically for up to three months and sometimes up to six months, so prepare early. If your present mortgage deal ends in the next six months, speak to your lender now to see what follow-on products it can offer and ask an independent broker to find out what deals might be available to you by way of comparison.

Lucky borrowers with low tracker rates, typically those taken out two or more years ago, can probably afford to wait and continue to make big savings on their repayments. Overpaying on the mortgage each month should also cushion against falling property values and help maintain a decent loan-to-value ratio when the time comes to remortgage.

If there is a big exit penalty on your tracker deal it probably does not make sense to try to pull out and fix now, brokers advise.

Those with low SVR deals who have no exit penalties could also take a gamble and wait. But they should keep a close eye on interest rates and property prices, advises Melanie Bien, director at mortgage broker Savills.

“If you're not tied into your mortgage rate you could stay on the low variable rate for as long as possible and then move to a fix when you feel rates are going to rise,” says Bien.

“Of course, this strategy depends on your attitude to risk. If you can't afford a significant jump in the base rate it makes sense to fix now. Historically, the base rate at five% is more likely than the current 0.5%.”

Can I Protect Myself From Rising Rates Without Fixing Immediately?

Yes. There are a number of ways borrowers can enjoy low variable rates but protect themselves from a big rise. The 'drop lock' mortgage facility is growing in popularity among uncertain borrowers who want to enjoy a variable rate now but think they will want to fix it in the near future.

With a drop lock, borrowers can take a tracker but lock into a fixed rate with the same lender at any time during the deal term without having to pay a large exit penalty.

Cheltenham & Gloucester (part of the Lloyds TSB banking group), Nationwide and RBS NatWest all offer a drop lock facility. Ask your lender when you take out the tracker if the option applies.

The main downside is that the property will be revalued if you decide to fix, except with NatWest. Borrowers will also have to pay a second arrangement fee - and it is not unusual for this to top £1,000.

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