In times of economic uncertainty, which kind of mortgage should you entrust your home and family’s future to? We take a look at the prospects.
Generally the old adage ‘safe as houses’ still holds. Houses and the land they stand on are material assets – even if their nominal market value declines the value of houses and land as houses and land remains a constant. At a time when bank savings generally return a negative interest in real terms and, like bonds, are exposed to fragile looking currency markets, bricks and mortar are definitely still the way to go – if you can afford to.
Mortgages and interest rates.
The cost of any type of mortgage, including fixed rate, tracker and variable rate mortgages, is ultimately dependent upon the base interest rate set by the Bank of England. It’s moved up or down to control inflation, while also trying to match movements in the rates of other countries to keep the UK attractive to inward investment. The real difference between these mortgage types is that they spread the costs of your home loan in different ways. Which is most attractive depends in part on how base rates move over the duration of your loan agreement.
Interest rates are at historic lows but a multitude of developments in the last few weeks will, logically, set them rising. The devaluation of sterling against the dollar and other currencies (especially post-Brexit) means increased prices of imported goods, oil prices are reviving too, and the US Federal Reserve has just announced a plan to drive up its own base rate for the next three years (from the current 0.5% to 3%). Nevertheless expert opinion is that UK rates will not move much, and certainly not quickly. A variety of factors mean there’s little scope in the economy to move them.
Fixed rate mortgages
These are an agreement between you and the lender not to vary the interest rate on your loan for a specified number of years. The advantage is the peace of mind of knowing exactly how much you’ll be paying – so you can match the size of the loan you can afford against your foreseeable household income.There are two main disadvantages. One is that the rate is set by the lenders best guess as to what the average base rate will be over that period. If they set it too low there could be a sudden hike at the end of the agreed term. If they set it too high you’ll be paying out more for your home for those first few years than perhaps you needed too. At the end of the agreed term, you may be moved automatically onto a variable rate mortgage. Lenders have a habit of treating their already captured market less generously than new borrowers, so the rate they shift you onto may not be the most competitive you could get if you remortgaged with someone else, but that means some hassle on your part and associated fees.
Variable rate mortgages
These allow the lender to move the rate, and your outgoings, up and down without consultation with you. Generally, they rise and fall in line with the base rate, but not necessarily. The lender can raise or lower them, or just not pass on rate reductions, for their own commercial reasons. If you’ve borrowed from a reputable lender you can be confident the rates will stay reasonable, but just because a particular lender’s offer seemed attractive when you were comparing them at the beginning doesn’t mean it will stay looking attractive over the whole duration of the loan. Even if it does, you have no insulation from fluctuations in the economy that affect the base rate. Although these aren’t expected to move quickly at the moment they can do. Some of us remember the UK’s dalliance with the European Exchange Rate Mechanism in 1992 when base rates were hiked 2% overnight.
These loans vary only in line with the base rate and not, theoretically, in just any way the lender cares to adjust them, which means the competitiveness (or otherwise) of your mortgage is fixed in comparison with the market. Your outgoings will still vary in accordance with base rate changes. The other disadvantage is more subtle – if the lender knows they can’t play with their rates later they’ll be disinclined to offer you such an attractive rate at the beginning to lure you into the deal. If you’re someone happy to consider future remortgaging to take advantage of other lenders’ “introductory” offers then fully variable rates are more attractive.
If you think interest rates could rise substantially over the next few years, and your income won’t look carefully at fixed rate mortgages. If you have the inclination to play the market you should consider variable rates. Tracker mortgages are a compromise. Avoid terms and conditions that lock you in and penalise you for replacing one loan with another – selecting ‘no overhang’ means you’re allowed to repay the loan without penalty after an initial period.