The hidden dangers of a cheap mortgage rate
By Lauren Thompson
7:00AM BST 14 Jul 2012
Thousands of home owners lured into taking out cheap variable-rate mortgages could be hit with higher repayments even if Bank Rate stays at its record low, experts have warned.
Banks and building societies are increasingly pushing so-called discounted variable mortgages. These are pegged at a certain amount below the lender’s standard variable rate (SVR).
Unlike tracker mortgages, which go up and down in line with the Bank of England’s official interest rate, lenders can increase mortgage rates linked to an SVR at any time.
Yorkshire Bank and the Leeds, Nottingham, Market Harborough and Cumberland building societies are not currently offering tracker mortgages, preferring instead to have discounted variable deals.
This gives lenders greater control over the amount that home owners pay.
Aaron Strutt of Trinity Financial, a mortgage broker, said: “Home owners can be tempted by discounted variable rates because they can be cheaper than a tracker or fix. But many have been caught out recently as SVRs have increased.”
Next month, 4,500 borrowers with ING Direct will see their SVR increase from 3.5pc to 3.99pc. A home owner with a typical £150,000 mortgage will see monthly payments jump from £751 to £791, a rise of £40 a month.
More than a million home owners with Halifax, Co-op, Yorkshire Bank and Bank of Ireland have also seen increases in their SVR in recent months, despite Bank Rate being on hold at 0.5pc for more than three years.
Mortgage brokers said the SVR increases had come about largely because of the crisis in the eurozone, which has pushed up the cost of borrowing for banks. This means that mortgage rates are going up, even though Bank Rate is expected to stay on hold for at least another year.
David Hollingworth of London Country, another broker, said: “Bank Rate now has much less correlation with the cost for lenders to fund mortgages. It is therefore perhaps not surprising that some, especially smaller building societies, are moving away from trackers.
“Lenders want to have control over their mortgage rates and increase them if they need to, especially in this uncertain economic climate.”
Nationwide recently admitted that its old SVR, of only 2.5pc, which was capped at 2 percentage points above Bank Rate, cost the building society £750m last year. In April 2009 Nationwide increased its SVR for new customers to 3.99pc and scrapped the link between the SVR and Bank Rate.
Coventry Building Society has also scrapped the link to Bank Rate on most of its variable deals. Instead of tracker rates, it now mostly has so-called Flexx rates, which are variable and can be changed by the society at any time. Flexx deals come with no early repayment charge, so borrowers can escape without penalty.
Lenders that offer both trackers and discounts often price the latter slightly lower to make them more attractive to borrowers.
Newcastle Building Society, for example, has a two-year discounted variable deal at 3.85pc with a £690 fee. Monthly repayments on a £150,000 mortgage would be £779. But Newcastle’s two-year tracker rate is slightly higher, at 3.95pc, and there is a bigger fee of £995. Monthly repayments would be £788. Both deals are for borrowers with a 20pc deposit.
Figures from the Council of Mortgage Lenders show that 8pc of borrowers took out a discounted deal in April 2012, compared with just 3pc in April 2009. Almost 200,000 borrowers have taken out a discounted mortgage over these three years.
Mr Hollingworth said: “With a discounted rate you may get a slightly lower rate initially, but there is always the threat that it could be altered irrespective of Bank Rate movements. SVR increases are happening right now and, with all the turmoil still happening in the eurozone, other banks could still follow suit.”
Home owners who don’t want to be at the mercy of banks’ variable rate increases have the option of either a fix or a tracker. The choice partly depends on what you think will happen to Bank Rate in the next few years, as well as how much risk you can afford to take with your mortgage payments.
Howard Archer, an economist at IHS Global Insight, thinks Bank Rate will stay at 0.5pc until 2014. The Centre for Economics Business Research, meanwhile, thinks interest rates will remain on hold until 2016.
If you think rates will stay low for the foreseeable future, you could opt for a lifetime tracker. These are pegged at a certain amount above Bank Rate for the entire mortgage term, usually 25 years.
HSBC has a lifetime tracker at 2.99pc (2.49 percentage points above Bank Rate) for those with a 40pc deposit. It has no arrangement fee and there is no exit fee, meaning you can leave the deal at any time and switch, for example, to a fixed rate instead. Monthly repayments on a £150,000 mortgage would currently be £711.
Yesterday HSBC launched the cheapest ever five-year fix at 2.99pc for those with a 40pc deposit, as well as a seven-year fix at 3.99pc. Both mortgages come with a £1,499 fee. Monthly repayments would be £711 or £791 respectively.
Those with a smaller deposit of 25pc can get a lifetime tracker with First Direct at 3.49pc (2.99 percentage points above Bank Rate) with a £499 fee. Monthly repayments would currently be £750.
The same borrower could get a five-year fix with Cumberland Building Society at 3.96pc with a £699 fee. Monthly repayments would be £788.
A spokesman for the Building Societies Association said: “Some mutual lenders do offer trackers, while others offer alternatives such as fixed and discounted variable rates. The mix of these products is a commercial decision which reflects the cost of funding and provides choice to consumers.”