You can barely open a newspaper today without reading an article about housing prices and interest rates. With customers struggling to get on the property ladder and with the number of repossessions and individual insolvencies on the up, interest rates remain a hot topic as lenders look for solutions to help existing and potential borrowers own their dream home.
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We have seen three Bank of England Base Rate rises in the past nine months, which has meant that many people are paying hundreds of pounds a month more in repayments. It is not only customers who are concerned about further hikes. When questioned earlier this year by GE Money Home Lending, 83 per cent of brokers in the UK stressed rate rises as their top concern for 2007, compared to just 64 per cent in 2006. So, if rates continue to rise, what can lenders do to help alleviate the problem?
A timely launch?
It the end of March, we saw Nationwide Building Society become the first major mortgage lender to offer a 25-year fixed rate loan. This US-style long fixed mortgage is designed to address buyers’ fears of rising rates, and has a timely launch, given what has been record demand for fixed rate products.
According to recent figures from the Council of Mortgage Lenders (CML), 85 per cent of first-time buyers chose a fixed rate deal in January 2007 – the highest figure on record – and just over 70 per cent of home movers also chose a fixed rate.
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A main reason for the high number of fixed rates being taken out could be that the average rate for all fixed rate deals is 5.27 per cent, just 0.02 per cent above the current Base Rate. With further changes predicted, those on fixed rates at this rate value will benefit any hikes made by the Monetary Policy Committee.
However, it is not only home movers who are looking at long-term fixed rates.
First-time buyers
An increasing number of first-time buyers (FTBs) are opting for this type of product as they see it as a way of protecting themselves against the risk of further rate hikes. It also allows them to choose the certainty of fixing their monthly mortgage payments and to plan ahead with confidence.
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For FTBs, fixed rate mortgages can offer the stability required in the early days of a mortgage term but as many FTBs tend to move house within the first five years it may not be the best option for them to have such a long-term product. When they decide to move, they will need more money and will either have to borrow more money from their existing lender, at the current rate, or pay a penalty.
But while this US model of lending might seem tempting to home buyers who fear further interest rate rises, and want to secure cheap monthly repayments for the long term, it may not be the answer they are looking for.
Too good to be true?
Long-term fixed rate products do allow borrowers to help budget and plan their finances over a set period but it can prove a costly mistake if an individual’s circumstances change. Some long-term fixed rate mortgages also have penalties for borrowers who want to withdraw from their agreement earlier than the agreed term of the loan.
The launch of Nationwide’s 25-year product has prompted experts within the industry to warn borrowers to ensure that they look carefully at their personal circumstances before signing up for a long-term deal. The main reason is not only because of the early repayment penalties but also because rates will not rise forever and if the rate drops below the rate they are committed to, they may find themselves in a worse position than if they had taken out an alternative type of product.
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Not all doom and gloom
There are benefits to long-term fixed rates. Someone who remortgages every two years could pay at least £5,000 in admin fees in just 10 years, but by having a fixed rate mortgage over the same period, they would save on admin fees as they would not be switching provider or mortgage within the term.
Also, if rates continue to rise in the coming years, borrowers will be confident in the knowledge that their payments will be stable and will not fluctuate.
This type of product is best suited to borrowers who intend to keep their property for the long term, and prefer the security of a constant monthly payment.
The way forward?
However, while the 25-year fixed rate mortgage has been in the US for some time, it is yet to be tested fully in the UK. Lenders who have previously tried to launch similar products have been forced to withdraw such products due to a lack of demand.
Following this latest offering, critics are arguing that if borrowers are intending to move property or switch lender after a few years that they should be opting for shorter-term fixed rate products which are often over a two to five-year period.
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By opting for a shorter fixed term, borrowers are ensuring that they have the security of a fixed rate but also have the flexibility to move should rates drop or circumstances change.
Whether now is the time for long-term fixed rates or not, we will have to wait and see. But in the meantime borrowers have a wide range of fixed rates available to them over shorter terms which will guard them against any future rises.
