With rumours running wild about another interest rate rise next month and fixed rate mortgages disappearing faster than you can say inflationary scary monster, what can homeowners do to protect themselves against painful higher interest rates?
The main reason for the expected rise in the base rate by the Bank of England next month is that inflation jumped from 2.8% to 3.1% in March, as measured by the consumer prices index. Alarm bells rang and the governor of the Bank of England had to write to the chancellor, Gordon Brown, to explain why inflation had risen more than one percentage point above the 2% target.
The only way to kill the inflation beast is to hoist interest rates and, in anticipation of a rise, the City pushed up their swap interest rates, the future rates that the banks and building societies are charged for borrowing. Hence the withdrawal of some cheap fixed-rate mortgage deals from a number of lenders.
The end of cheap lending?
What it means to us is that we won't be seeing the low interest rates of between 3.75% and 4% enjoyed a couple of years ago for some time to come.
The Bank of England put up interest rates by a quarter of a point in August, then again in November and once more in January, taking the base rate to 5.25%. Some economists are now talking about the base rate rising to 5.75% and even 6% (the real scare mongers have mentioned 7.5%). Certainly, most expect another quarter-point rise in May to 5.5% but some think it could be a half a point - the last time the Bank of England moved base rate by more than 0.25% was December 1995.
If the base rate truly is heading towards 6%, mortgage rates could start edging up towards 7.75%, from 7.25% today. And we won't be able to rely on bouncing house price rises to get us out of a tight spot. Economists don't expect the mini boom seen over the last few years to continue. The Financial Services Authority has recently been talking about a 20% fall in house prices.
Fine if you’re on a fix, not if you’re on a variable
Nevertheless, another interest rate rise won't unduly affect the majority of homeowners, because around 60-70% of mortgage borrowers are already on fixed-rate mortgages.
And if you've been sensible and paid a bit extra each month, you've made your own safety net. You could readjust your mortgage payments so you are paying the same as you were before.
That means those on standard variable rate (SVR) mortgages and on fixed rate deals that are just about to end are going to feel the pain the most. Another base rate rise could add almost £50 a month to a £150,000 variable rate repayment mortgage over 25 years and that's on top of three other recent rises.
Too late to get a fix?
Fixed-rate mortgages have been getting more and more popular over the past year because you know what you will be paying every month.
The Council of Mortgage Lenders reported that in February, fears that further interest rate increases could be on the cards caused 87% of first-time buyers to choose a fixed rate mortgage, up from 84% in January.
Following the publication of the bumper inflation figures last week, a number of high-profile lenders withdrew many of their fixed-rate offers, or made them less attractive to borrowers.
Nevertheless, while many fixed-rate mortgage deals have already gone, it's not all gloom and doom because there are a few good deals still on the market at time of writing under 5.5% but you have to hurry.
Which fixed-rate deals should you go for?
Most people take out fixed-rate mortgages for between two and five years. If you want more security, go for a five-year deal. Giraffe Money is offering 5.35%, while Teachers and Britannia building societies both charge 5.39% on their five-year fixed rates. Two-year deals at 5.34% can be had from Stroud & Swindon and Skipton building societies.
But you have to remember if you take out a short-term deal, in two or five years' time you could be paying another lot of fees if you want to switch again or arrange another deal.
You could go for a 10-year, 15- or 20-year fix but the problem with these types of loans is that the redemption charges can be hefty and few of us are willing to take the risk on interest rates.
Norwich & Peterborough Building Society's 10-year fixed rate is currently 5.52%, its 15 year costs 5.74% and its 20 year 5.68%. While you can overpay by up to 10% a year penalty free, if you redeem the mortgage within the term there's a fee of around 6% in redemption charges on the outstanding balance. On the plus side, you would always know how much you will be paying each month but if interest rates fall you could be stuck paying an expensive mortgage.
Alternatives to fixed-rate mortgages?
If you can’t find a good fixed-rate deal, you could opt for a discounted or a tracker mortgage that follows the Bank of England's base rate.
While they can be cheaper than standard variable rate mortgages, they are still variable and your mortgage payment will go up if the base rate rises (it will also go down when rates fall once more).
Remortgaging not right for everyone
However, the problem with switching to a fixed-rate mortgage is that sometimes the fees can outweigh the advantage of the lower interest rate especially if you have a smaller outstanding balance left on your mortgage.
So you have to make sure you do your sums carefully.
