Anticipation that the Bank of England’s Monetary Policy Committee (MPC) will put up interest rates in May is running high. Among all the evidence to support that view – higher inflation, soaring property prices, apologetic letters to the Chancellor and so on – perhaps the clearest sign of an expected hike is the fact that fixed rate mortgage deals are disappearing from the market faster than rats abandoning a sinking ship.
Fixed rate mortgages are hugely popular among canny borrowers. Council of Mortgage Lender (CML) figures last month revealed a record 87 per cent of first-time borrowers opting for fixes, while overall, fixed rate deals accounted for 76 per cent of house purchases in February.
The logic for the borrower is watertight – fix your mortgage payments for the next few years, providing a guarantee over the price of your mortgage and insulating you from any shifts in the Base Rate. Back in February this made even more sense because fixed rates were proving particularly attractive after January’s shock rate increase.
Mass desertion?
But how come the fixed rate market remained firm after January’s interest rate, but now just the possibility of an increase has triggered mass desertion of product? David Hollingworth, head of communications at London and Country, explains: “Lenders have a tranché of funds at a certain price, so they will run with that deal for a certain period of time. When interest rates go up, so will the price of funds and those deals disappear.”
Although there is uncertainty as to how high interest rates will go over the next few months, Hollingworth does not believe that fixes will disappear completely. “We have seen a number of lenders withdraw their fixed rate products for immediate re-pricing, but they won’t want to withdraw from the fixed rate market full stop,” he says.
“It is just a question of the price that they can be in the market at. You
will continue to see a full range of fixes available, but they will be at a higher rate than before. Fixed rates make a lot of sense and borrowers
like them, so lenders will want to be involved in that market.”
Danny Lovey, who operates as broker The Mortgage Practitioner, agrees: “News of the death of the fixed rate mortgages is much exaggerated,” he says. “They were cheap against the real swap rates – the Halifax and Abbey two year deals, for example – and the yield curve is fairly flat, so there is no reason why they should go out of fashion, just a bit more expensive reflecting the real swap rates. Also competitive pressures will ensure a few brave souls go ahead of the game with their rates.”
Lovey believes that recent activity in the fixed rate sector is pre-emptive ahead of the expected rate rise. He explains: “As we had in January, it will take a week or two to settle down. But don’t forget that in January it took a bit more time because the rise came before the market was expecting it. This May’s expected rise is likely to be to the tune of a 0.25 per cent, but 0.50 per cent would maybe get people scurrying around, trying to work out if another is coming.”
Rob Clifford, chief executive of Mortgageforce, argues that the popularity of fixed rates means that lenders cannot risk dropping the product. “The UK market is fiercely competitive and over-supplied, lenders are squabbling for market-share,” he says. “So they can’t afford to withdraw fixed rate products and take the hit. Something like 70 per cent of borrowers are pre-disposed to fixes and often they tell the intermediary that they want a fixed rate even before he gets his briefcase out.
“I think there will be two interest rate increases by the Autumn, so I think we will see more re-pricing of fixed rate products rather than lenders pulling out of the market. Of course, the cynics say that lenders only offer sexy fixed deals when rates are low, but I don’t believe lenders are that predatory. It’s simply that fixed rates are lower when interest rates are lower – they increase when the rates go up, and borrowers needs to be aware of that.”
In fact, lenders recognise the popularity of fixed deals so much that we could see intensive activity in the sector once again when rates settle down, according to Thomas Reeh, chief executive of blackandwhite.
co.uk: “The market has already factored in another rate rise in May, as the MPC needs to keep inflation in check. There is a psychological barrier to overcome as well. In percentage terms borrowers are facing an increase of over 20 per cent for their mortgage payments compared with 18 months ago. There is hope that rates may come back down later in 2007, provided inflation is in check, and that could see some aggressive fixed rate
pricing.”
Reading the signs
According to some commentators, the nature of the UK mortgage market, its competitiveness and product innovation, means that smart borrowers can benefit if they know how to read the signs of the changing economy and are able find the right product at the right time. Mal McConechy, mortgage director of Home of Choice, explains: “There will always be a market for fixed rates as long as the Bank of England or government continue giving messages that rates are likely to rise or the money market or swap rates reflect the direction of the cost of money. Lenders like this as they can make a profit and it is the smart client, via his adviser who wins the bet as to when rates have peaked.”
McConechy points out that as the MPC’s rate hikes are precautionary measures, it is entirely possible that they may come down just as quickly as they go up if economic conditions improve. “The cycle of rates is on the up with one and possibly two more 0.25 per cent hikes anticipated,” McConechy says. “This will have a marked effect in a year and if overcooked, it will force rates down again. Then the customer has the dilemma of when to come off the rate with high, up front fees to take into account. The broker needs to work out a payback time based on covering the cost versus savings, which may mean six or seven months before there is a real saving. To mitigate this, the best route is a Base Rate tracker and, if appropriate, an offset version.”
A complex picture
This paints a complex picture for borrowers, suggesting that their choices must be based on understanding the market as much as choosing the right mortgage at a particular time. But according to Steve Walker, managing director of Promise Finance, it is as much about luck as it judgement. “In simple terms both the borrower and the lender are gambling on what is going to happen to interest rates in the future, whereby the lender is investing its money and the borrowers are investing their debt,” he explains. “As the market settles and lenders get a little more confident about what the future may hold, I would expect fixed rate products to return, albeit with higher rates.”
Walker believes that many borrowers will continue to opt for fixed rates, simply because it is what they feel comfortable with. “There will always be those borrowers who prefer the comfort of knowing exactly what their repayments will be and will opt for a fixed rate, no matter what,” he says. “Provided the differentials between variable and fixed rates stay as they are, those clients who previously would have taken the fixed rate, will continue to do the same.”
Super-fees
The danger with this approach is that fixed rates do not always offer the best deal, even if the rates are competitive. Simon Lambert, mortgage expert for personal finance website thisismoney.co.uk, says there is a growing trend of loading low rate fixes with high fees. He explains: “Lenders are trying to keep fixed rates to a low level to keep them eye-catching. However, they are imposing high arrangement fees, or arrangement fees equal to 1.50 per cent of the loan value. There are fixed deals currently available at low 5 per cent rates, but they come with arrangement fees of £2,000. These super-fees are becoming more prevalent on the best deals.”
Although the trend began in the buy-to-let sector, where borrowers often opt for interest only mortgages and therefore tend to want to keep their monthly repayments as low as possible so they can be covered by rental income, higher arrangement fees are cropping up in the mainstream products from lenders like Halifax and Nationwide.
Lambert says there is a danger that people keen on fixed rates will not realise the impact of the higher fees. “Borrowers need to be very careful working out what it is going to cost them,” he says. “If they have a mortgage of less than £100,000, then a fixed rate with such a high arrangement fee is probably not worth it.
“Borrowers should speak to a broker to find out how much the deal is going to cost, or use one of the mortgage repayment calculators to work out the actual cost of the mortgage by adding the fee to the total monthly repayments so they can accurately compare products.”
Lambert feels that super-fees upfront could ultimately cause as much furore as high exit fees. He says: “The way the lenders make their profit is by taking big fees, and also then letting borrowers add these fees to the loan. They might be able to offer eye-catching rates, but they are not endearing themselves to the market, in the same way that consumers have become savvy to high exit fees. Lenders have borrowers over a barrel as they like fixes. But they can’t keep increasing arrangement fees – what happens when they hit £3,000? Borrowers simply won’t take out
these mortgages.”
Lovey, a fierce campaigner against exit fees, says that increased arrangement fees will find a limited audience. “I’m not concerned about lenders charging higher fees if they are transparent and upfront,” he says. “They will just not get my business for 99 per cent of my clients. It is only the 1 per cent that it might suit. This is particularly popular in the buy-to-let market.
“The mainstream will remain with more competitive arrangement fees and more lenders are pricing things with low or no arrangement fees, but a higher rate, which particularly suits people with lower mortgages. In all, it’s horses for courses.”
David Connolly, head of products at Advantage, says that advice from brokers will be paramount when it comes to assessing the competitiveness of such products. “I think we will see more mortgages with higher arrangement fees,” he says. “Affordability is a challenge in the UK. In order to ensure that borrowers can afford the mortgage, lenders may take a loss on the actual rate, but make their profit from arrangement fees.
“In these circumstances it will be down to brokers and the sourcing systems to find the details and explain to borrowers their options. Brokers will need to have the conversation over arrangement fees at an earlier point, so that borrowers can make an informed choice. There will always be a place for products with higher fees and lower rates.”
Reeh agrees that broker input is vital, but he warns that borrowers should not just focus on price, shaving a few pounds, but sacrificing service as a result. “Lender fees and charges have more than doubled in the last two years,” he says. “Find.co.uk has the average lender fees now at £609 per mortgage across the board. But low fixed rates are often combined with rubbish service and really high fees, because lenders know that some customers will be attracted to a low rate like bees
to honey.
“It’s really important to sit down with a qualified adviser and understand the true cost and the service that is provided by lenders. The latter is often forgotten and it’s really important when you get what you pay for, for example, offshore call centres vs UK-based support. Service also includes turnaround times to completion, which vary across the board.”
Other options
If short-term fixed rates are not looking so attractive at the moment, what other options do borrowers have? Longer term fixed rates of 10 and even 25 years are now available, but Reeh believes they are only suited to niche borrowers. He says: “They offer certainty in terms of repayments, but they are risky.
“Certainty of repayments must be balanced against the cost of a significant early repayment charge should the 10-year mortgage be redeemed early. There is also the possibility that rates could come down equally fast as they have risen and the early redemption charge would be even higher should the customer wishes to exit
the deal.”
Reeh suggests that borrowers look at flexible products that give them the opportunity to put more into their mortgage when finances allow. He explains: “Customers should always look at products where overpayments can be made. If they are in a position to over-pay, even small amounts will reduce their capital balance and the amount of interest charged, and at the same time build a buffer against rate fluctuations. This position can be further enhanced by paying any ‘one off’ sums into the mortgage, like an annual bonus.”
Capped deals were popular in the 1990s, but they have virtually fallen off the map now following the growth of fixes and trackers. Could we no see them return? “I wouldn’t be surprised if we see capped rates coming back,” says Paul Hunt, head of marketing at Platform. “Some of the Base Rate trackers are looking good, so the combination of that with a cap could be popular. It would just depend on how competitive the cap is.”
Platform has bucked the trend by actually reducing the price of its fixed rates, even with an expected interest hike in the offing. Hunt explains: “The thinking behind the new rates is that competition is fierce in the specialist sector and our pricing was not as competitive as it was in previous years. We assessed the impact of the competition, we assessed if we wanted to be more competitive, we understood the market and decided to be more aggressive and changed our pricing accordingly. We were also fortunate when we bought our fixed rate money, so we are able to make are rates very competitive.”
Hunt’s view summarises the appeal of fixed rates, to both lender and borrower, as well as making clear the dilemma to consumers. Fixed rates are not going away, but they will be more expensive, so borrowers need to decide if peace of mind is worth the extra cost.
Hunt concludes: “Fixed rate products are sold more in a rising market because they provide a level of certainty to borrowers. People are used to lower rates of course, but that won’t reduce the market. At the moment, borrowers will have to take what’s
out there.”
