Whilst it remains unclear how close we are to a collapse of the Euro, one thing is clear; predicting how the fallout would affect financial markets is no easy task, even for seasoned financial experts.
In pure mortgage terms, one set of products appears to be particularly risky in the current market; is any which tracks a variable rate as opposed to the Bank of England base rate. These include discounted rates, variable rates and Libor-linked or Libor-rate deals.
All of these products could be subject to increases if the Euro collapsed, even if the monetary policy committee of the Bank of England decides to keep interest rates low.
When the BOE base rate was reduced heavily in 2008, many lenders did not pass these cuts into their variable rates for some time; as doing so would have seriously jeopardised their ability to remain afloat.
Similarly, in the scenario of the collapse of the Euro and or the default of a nation such as Greece, Spain or Italy, this would undoubtedly cause a similar crisis in the banks leading to a drying up of money markets and upward pressure on banks’ variable rates.
Most discount-rate mortgages are offered by smaller building societies, which typically have a much lower risk exposure and would be better insulated against having to raise their variable rates significantly in a similar scenario. However, they are not immune to this risk.
More concerning, though, are Libor-linked deals; these are linked to the going rate of lending between UK banks and could rise a lot if we saw more market turmoil.
Even so, tracker deals could still be a risk; who knows how the different repercussions of this kind of event could ultimately play out?
So when looking at current products, comparing the difference between fixed and variable rates, in general, is well worth doing. I would take a pragmatic approach where the difference is minimal, as it seems likely that the last string of bailouts may yet prove to be the tip of the iceberg.
Probably the biggest mortgage-related question on everyone’s lips is whether to fix their mortgage and at present, it is certainly difficult to predict future interest rates.
I can remember a conversation with a client almost 18 months ago where media coverage suggested interest rates were going to shoot up, and they were worried the tracker product I had recommended might become very expensive.
In my opinion, whether to fix your interest rate or not is a two-part question. Firstly consider your attitude to risk and the severity of that risk.
If you have ample income to afford higher rates, it comes down to your preference of whether to gamble on variable-type products. But, if you cannot afford for your mortgage payments to go above current figures, you should not only be considering a fixed rate but also trying to reduce your borrowing levels asap.
The second part of the answer comes down to the difference between fixed rates and variable products. If the difference between a suitable variable product and fixed deals is relatively low, even if you are a risk taker, it may be worth opting for a fixed rate. However, with bigger differences, it becomes harder to say.
Let us compare a 5-year deal currently on offer with one lender of 6.49% with a 25% deposit to their 2-year fixed and 18month tracker product; this is 3-4% higher, and that means the chances of it being good value for money long term are much lower as it would require average interest rates over the next five years to be over 5% or so.
That is a significant increase from current rates, so I would only recommend a fixed in this scenario to someone on the borderline of what they could afford and needing absolute long-term security.
Many lenders are touting products with an option to switch to a fixed deal at a later date; without early repayment charges. But for those who would be at serious risk of being unable to afford their mortgage if rates went up, this is likely to be a poor option, as the fixed deals available at the time are likely to be higher then as well.
It remains likely that while interest rates must increase at some point, overall market competition will do too, and to some extent, increases in bank base rates are likely to be met with at least some reduction in lenders’ margins.
Current two-year fixed deals come with an average margin of about 3% over the bank base rate, which would have been unthinkable three years ago, so at some point, slowly but surely, these differences must be eroded by competition as the market improves.
One of the most bewildering and confusing items on any mortgage illustration must be the Annual Percentage Rate or APR listed on a product.
APR gives a comparative measure between various loans to show the overall cost of borrowing on an annual basis, taking into account a broad range of fees, not just the interest alone, as well as giving a more direct comparison of the impact of a daily calculation of interest versus other less favourable terms.
Now, that is a good thing where the calculation makes sense, but for mortgage products, in its current guise, it makes no sense at all.
A simple look at the best buy tables on our website will show you; a product far cheaper during its initial deal may have a much higher APR than a product with a considerably higher interest rate and identical fees.
That is because the APR is calculated over the whole lifetime of the loan and will include the reversion rate of the product after its initial term.
There are several reasons why this is misleading;
- Reversion rates are generally variable and are not linked directly to the Bank of England Base Rate. In two years a lender with a previously un-competitive reversion rate could lead the market and vice versa. Hence it is not a factor that should play a major part in the decision-making process.
- Generally, customers should remortgage regularly during the early years of their mortgage repayment to ensure a competitive interest rate, including the reversion rate after the initial mortgage term distorts the picture.
- A clever design can skew the figure. Lifetime trackers appear very competitive because they have no reversion rate, and refunding upfront fees affects the calculation but could cost a pretty penny if the loan never goes ahead.
APR is a system that was never really designed for mortgage contracts but has become a legal obligation when advertising them; due to the confused dual regulatory system; between the FSA and the Office of Fair Trading. APR makes some sense on unsecured loans and little in the mortgage market.
It is high time that dual regulation ceased and APR calculations either scrapped on mortgage contracts or replaced with something far more specific to the complex nature of a mortgage product.
When a mortgage broker arranges a mortgage for a borrower the commission they receive (if they take the commission as opposed to a fee) is not standardised but there is however only a limited difference from lender to lender. Typically the percentage is about 0.3 to 0.35% for a residential mortgage with good credit, 0.40 to 0.45% for buy to let mortgages, and slightly higher for adverse credit applications.
Why then are several banks, one of which I won’t name but is almost entirely government owned (guess who?) is loading rates available via intermediaries by anything up to 1% against an equivalent product available through them direct? If these lenders are proposing that it costs them more to accept intermediary applications this is farcical.
They may argue that the intermediary market would simply direct too much business to them which they don’t have funds to supply. This is plausible but I think it is actually pricing intermediary products out of the market to attract business from consumers direct who can then be goat herded into higher rate products with down valuations and clandestine credit scoring, or even lower rate products with ridiculous fee’s which are more expensive in reality. Without a broker to argue the case and guide on fee’s most people will simply accept being cascaded to a higher rate without asking difficult questions, or being declined an application having paid for valuations and the like.
I want someone to actually put the question to these banks, how is this rate loading fair practice and why is it in place? Because to the educated it seems to be the intention to get mortgage advisors out of the market so that dodgy products can once again be sold in bulk. Just look at the return of long early repayment charges on market leading rates as a sign that lenders are looking for ways to lock customers into potentially crippling mortgage rates.
The Woolwich has announced a new tracker at 1.48% above the base rate for the first year, reverting to 2.49% above the base rate for life, giving their lowest-ever headline mortgage rate of 1.98%; currently.
The product has a minimum loan of £200,000 and a maximum of £500,000, so it is restrictive; early repayment charges are 2% until 31/01/2013, meaning it does tie you into the rate for a prolonged period.
The product has a £999 arrangement fee; based on a loan of £200,000 at 60%, a valuation fee of £415, a lender Conveyancing fee of £126, a land registry fee of £280 and a completion fee of £35, while APR is 3.0%.
The big caveat to this product is that the option to switch to a Woolwich fixed rate without penalty during the early repayment charge period, which Woolwich call “drop lock”, does NOT apply to this product.
So while its headline rate may be very tempting if there are significant rises in interest rates, particularly in the second and subsequent years of the mortgage, it could become very costly indeed, particularly as early repayment charges on a minimum loan of 200K would amount to four thousand pounds as well!
For this reason, I would recommend seeking mortgage advice about the suitability of this product if it has your interest, and as usual, read the Key Facts Illustration prior to making any decision on a mortgage product.
Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage or any other debt secured on it. There may be a fee for mortgage advice. The amount will depend upon your circumstances but it is typically £200 or up to a maximum of 1.5% of the loan value.
Some buy-to-let and commercial loans are not regulated by the Financial Services Authority.
