Borrowers flocking into discounted variable rate mortgage deals in the expectation that mortgage rates will fall significantly over the next twelve months are ignoring the fact that fixed rate deals are more attractive in relative terms than ever. Furthermore, they are exposing themselves to the risk that base rate expectations, which have been very volatile in recent months, could turn again and head upwards.
It is only very recently that money markets have begun again to price in that base rates may fall by the end of 2005. Over the last few months, market expectations for interest rates have see-sawed wildly adding to uncertainty for mortgage borrowers.
Fixed rate deals have steadily been getting cheaper, however, and are now available at the lowest interest rates in 18 months in absolute terms.
Also in relative terms, fixed rates are exceptionally cheap compared to discounted variable rates. For example, the Money Facts, best buy five year fixed rate is just 0.06% higher than the two year discounted variable rate. To put this in context, a borrower with a £100,000 mortgage must only pay £5 per month more for the extra certainty that the five year rate would bring.
First year savings achieved by switching to the Best Buy1 five year fixed rate mortgage are now £1,590, up a staggering 16% from a month ago and 174% over this time last year. Fixed rate deals now offer the same or greater savings than discounted variable rates over both two and five years. Last month and a year ago, discounted rates offered greater savings in all categories.
The sting in the tail, exit fees, are getting more venomous. Over the last month, average exit fees levied when borrowers redeem their mortgages have climbed 7.8% to an average £180.
Jon Round, Remortgage Analyst at Your Move explains: "Borrowers can be very myopic when making big financial decisions with their mortgage. As recently as March this year, base rates were still expected to rise. There is now increasing speculation that the Bank of England will cut base rates at some point over the next twelve months. As a result, fewer borrowers are now willing to lock themselves into fixed rate mortgages.
"As we have seen this year, markets rapidly do U-turns and borrowers need to remember this when budgeting for their mortgage repayments. A variable rate mortgage can mean payments rising rapidly if rates rise.
"Fixed rate deals, which are determined using forward interest rates, are now exceptionally attractive relative to discounted variable rates as they have already taken into account the market’s expectations that interest rates will fall.
"A mortgage borrower preferring the current Money Facts best buy two year discounted variable rate of 4.49% over the five year fixed rate of 4.54%, must bravely be certain that interest rates will fall from this level and stay there for the next five years to be sure of saving money. Not even Mervyn King, Governor of the Bank of England can be sure of that."
