Mortgage outlook: Tracker, fix or hold on SVR
Although the Bank of England's base rate has now stood still for four months, the mortgage industry has been changing rapidly as lenders adjust to market conditions. John Charcol's senior technical manager Ray Boulger, takes a look at the current state of mortgages in the UK and advises on the best deals for borrowers.
Cost of fixing
The cost of fixed rate mortgages has risen sharply over the last two months, with many lenders increasing their five-year fixes by around one per cent, well in excess of the increase in swap rates. The Council of Mortgage Lenders (CML) recently defended lenders' pricing decisions, saying that there is a complex array of influences on lenders' pricing strategies at present.
This is undoubtedly true, but swap rates remain an important benchmark. It is, nevertheless, fair to point out that, contrary to the lack of it in the mortgage market, there is fierce competition for savings and this has been driving up rates for fixed rate savings bonds.
As lenders are now relying to a much greater extent on retail savings rather than wholesale funding this is pushing up their cost of funds, but at least it is giving them some money to lend.
3m Libor has been steadily falling all year and has just hit a new all time low of 0.90 per cent. The rates on most tracker mortgages have not been reduced in line but at least the falling Libor rate has meant they generally haven't increased and thus because fixed rates have increased sharply the spread between the initial pay rate on a tracker mortgage and a fixed rate has widened considerably.
Short-term fixed rates won't provide much protection against rising rates, especially if, as looks increasingly likely, they don't rise significantly for at least two years. Therefore, the best comparison with tracker rates is against a fixed rate for five years or longer and the premium over the initial tracker rate one now has to pay to secure the interest rate protection provided by a fixed rate for five years or longer has risen to well over two per cent.
This looks too much with the current outlook for interest rates. Thus, many fixed rates now look expensive and trackers generally look better value for borrowers who don't need the security of a fixed rate.
Too much of the anticipated rise in interest rates is now factored into fixed rates, and as a result, buying a fixed rate is no longer a way of beating most of the expected interest rate rise. In fact, if interest rates stay low for two to three years, a fixed-rate mortgage guarantees the borrower will pay a rate reflecting an expected increase which is far from guaranteed to happen within that timeframe.
Best value trackers
The trackers offering best value generally are lifetime ones, either those with no early repayment charges (ERC), such as HSBC, or a low ERC, for example Woolwich and Abbey, or alternatively those with a droplock option, which is only offered by Nationwide, Scottish Widows and RBS. (A droplock option allows the borrower to switch to one of the lender's fixed rates without incurring the ERC.)
Any of these options will leave borrowers free to switch to a fixed rate without significant costs when fixed rates again start to look attractive. An alternative would be a two-year tracker as the ERCs will only last for two years, but this is a more risky option because if it looks right to switch to a fix within two years it would be expensive because of the ERC.
As trackers generally look the best value, it makes sense for those borrowers on a low SVR to stay put. They won't incur any costs and they generally won't have any ERCs, thus leaving them free to switch to a fixed rate if and when they look to offer good value.
The cheapest lifetime trackers are from HSBC, at Bank Rate +2.24 per cent up to 60 per cent LTV and Bank Rate +2.45 per cent up to 75 per cent LTV, with both offering free legals on remortgages. For higher LTVs, Furness BS offers Bank Rate +2.69 per cent up to 80 per cent LTV, with a free valuation and free legals.
All these deals have fees between £799 and £999 and no ERCs, thus leaving borrowers the option to switch to a fixed rate at any time without incurring an ERC.
Staying put
Woolwich customers revert to a lifetime tracker rate of Bank Rate + 0.99 per cent and Nationwide, Cheltenham & Gloucester, Lloyds TSB and Intelligent Finance all have an SVR of 2.5 per cent. Halifax and Skipton's SVRs are at 3.5 per cent, but most lenders have SVRs between four per cent and six per cent, with many over five per cent.
Therefore, there is no point in borrowers with Woolwich, Nationwide, Cheltenham & Gloucester, Lloyds TSB and Intelligent Finance remortgaging unless perhaps they want a fixed rate, whereas borrowers on the higher SVRs will find it worthwhile providing their LTV is not over 80 per cent. For borrowers with Halifax and Skipton it is more marginal, but worth considering if their LTV is not above 75 per cent.
Some people will always prefer a fixed rate so that they can budget more easily, but if they are on a low SVR they need to think carefully whether it might make more sense now that fixed rates have increased so much to stay on their low SVR for the time being. Even if they eventually have to pay a little more for a fixed rate, if they have saved over two per cent on interest payments for several months, or maybe a year or two, they could overall still be better off.
Some people will be tempted to take a shorter term fixed rate, say two years, because they cheaper. However, the reason they are cheaper is that they don't provide protection from rate rises for very long.
Anyone whose LTV is higher than 80 per cent will have to pay significantly more for a new mortgage and so there is an added reason for people in this situation to stay on their SVR. If they are on a repayment mortgage, their LTV will steadily improve providing property prices don't start falling again. Obviously, if prices show any increase that will help to reduce the LTV further and make it easier to get a better deal in the future.
Finally, the smaller the mortgage the more relevant are costs such as arrangement, valuation and legal fees and so borrowers with a small mortgage who want to remortgage should choose a deal with a free valuation and free legals, and either a low arrangement fee or no fee. As the fees don't increase much with a larger mortgage they become proportionately less important for larger mortgages and so those with a larger mortgage should focus more on the interest rate, even if that means paying bigger fees.
Ray Boulger is senior technical manager for mortgage advisers John Charcol.
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