To fix or not to fix?

Francis Ghiloni attempts to answer the age old question that is particularly pertinent for mortgage borrowers at the moment

We are in an environment of historically low interest rates, with the Bank of England Base Rate held steady at 0.5% for quite a few months now. But the benefits of an historically low Bank Base Rate have not been passed on to many borrowers with some existing borrower rates as high as 5.5%. What is potentially more worrying is that some commentators have been saying that now is a good time for borrowers to get on to a fixed-rate mortgage as interest rates may rise in the coming months.

I am not convinced that this is the right thing to do. At the time of writing (30/6/09) borrowers can obtain a variable rate mortgage with a rate of under 3%. The cheapest three-year fixed-rate product is 3.90% and the cheapest five-year fix is 4.45%. That is a significantly higher rate to pay, costing an extra £81 per month for the three year and £127 per month for the five-year mortgage on a £150,000 home loan (capital and interest with a 25-year term). This is a high price to pay for the peace of mind of knowing what your mortgage payment is going to be each month. Borrowers should ask if it is necessary to do this. Is it likely that interest rates on mortgages will increase in the next six months?

The biggest driver for a rise in the cost of mortgages will be the cost of funding for the lenders. This is a reflection partly of general interest rates and partly of the cost of wholesale funding.  In the short term there is unlikely to be upward pressure on general interest rates.  The Bank of England has indicated recently that it expects rates to remain low going into 2010. The small positive signs that we have seen in the housing market will not outweigh the depressing effect of continued job losses.  The fragile state of the economy is likely to prevent a rate rise from being announced by the Bank anytime soon.

The cost of wholesale funding is another matter. In the months after the Bank of England started to make meaningful cuts in interest rates, the London Interbank Offered Rate (LIBOR) remained stubbornly high. The reasons given for this related mainly to the lack of trust banks had for each other. But we have moved on a great deal from this. There is much greater visibility over what the banks have exposure to. A number of banks have taken up the Bank of England scheme to swap out poor quality assets.  So there is greater clarity now but the cost of wholesale funding has been moving about.

SWAP rates (the rate at which lenders do business with each other) increased slightly at the beginning of June, but this seems to have been a blip with all but ultra-long (30 year) rates being lower than they were a month ago. Given this, what would be the reason for an increase in rates? If anything mortgage rates could get cheaper as more lenders come back to the market with competitive products. At present too few lenders are lending but with the encouragement from the Government and indeed with the margins to be made, the second half of the year may see some lenders who have not been active in the first six months being a bit more competitive.

There is a choice to be made. Sign up to a fixed-rate deal now at what could be a high price or sit and wait for a few months to see what happens. One thing is for certain. A borrower who has not reviewed their mortgage deal for a while and is sitting on  an interest rate of more than 4% may well be able to find a cheaper mortgage elsewhere, whether it is a fix or not. Homeowners need to make sure that they search the whole of the market to get the best deal possible.

Francis Ghiloni is commercial director of realpricecomparison.com