Cash in on a cheaper mortgage

THOUSANDS OF home-owners with fixed-rate mortgages may be missing an opportunity to gain hundreds of pounds each - by paying hefty penalties and switching to a lower rate.

Mortgage lenders are urging homeowners with high fixed-rate loans to consider paying the price of redeeming their mortgages to take advantage of deals on much lower rates.

According to the lenders, the new deals are so cheap that the benefits of switching can outweigh the cost of paying redemption penalties, valuation fees and legal fees, possibly leaving homeowners with a substantial gain.

In one example, a homeowner half-way through a 10-year fixed-rate pounds 100,000 mortgage with the Royal Bank of Scotland could realise a saving of pounds 6,100 - even after paying redemption penalties (see example).

Nick Deutsch, chief executive of FirstMortgage Direct, says: "It is highly unusual to find that it really does [make sense] to pay off a redemption penalty. But when they set the redemption penalties, some lenders failed to anticipate how low interest rates would get.

"Some of the redemption penalties set out in earlier years were couched in terms of 6-months' interest, which was inadequate to cater for the present interest rate regime."

First Mortgage calculates that a borrower who now has three years to run on a 7 per cent fixed-rate mortgage, with a redemption penalty of 6 months' interest, can switch to a three-year fix at 5 per cent.

That comes to a saving worth 2 per cent of the mortgage every year. With redemption penalties and re-mortgage costs of 3.5 per cent, the borrower will initially be out of pocket.

But after three years, the borrower will have made a saving worth 6 per cent of the loan. After deducting reredemption fees and remortgage costs, the borrower will save 1.5 per cent, or pounds 1,500 on pounds 100,000.

The benefits apply especially to fixed-rate loans taken out in 1993, when a spate of long-term fixes began to appear on the market. Many lenders offered fixes at 8 per cent or more in 1993, when interest rates were believed to have reached their nadir.

Five years later, long-term interest rates - which determine what rate a lender can offer - have plummeted.

Ray Boulger, of mortgage specialists John Charcol, says: "When it comes to re-mortgaging for a better rate, some people are deterred by valuation fees and legal fees. However, in many cases it will be worthwhile because rates have come down to so low a point.

"If you are thinking of taking a view as to whether it's worth switching, there are two things to look at: how much longer the fix has to run, and how much the redemption penalty is."

The switch is most worthwhile for homeowners with mortgages over pounds 100,000, where the interest rate benefits will be enough to pay the high fixed costs of re-mortgaging.

Homeowners should think carefully before going ahead. Many of the most recent fixed-rate deals have stiffer redemption penalties than their predecessors. And if valuation and legal fees are not kept to a minimum, the saving could be trivial.

If a fixed rate loan has just a year or two to run, the benefits of the switch are unlikely to pay off the initial cost of re-mortgaging. The switch, in effect, is a medium-term investment: it only works if it runs for a few years.

But the opportunities are there. Homeowners may not even need to pay the upfront costs of re-mortgaging when the price of the home has risen.

Stephen Knight, head of the Independent Mortgage Collection, a network of mortgage brokers, says: "The new fixed rates are significantly cheaper than a few years ago. It can in some circumstances be particularly worthwhile to pay the redemption penalty if the equity in your house has increased."

If the value of the home has gone up, lenders may be willing to add the costs to the value of the loan. A price rise increases the equity in the house, and thereby the security of the loan. In these cases, the amount being borrowed will rise and the time taken to pay off the mortgage may increase. But lower payments can then be realised without paying any upfront costs.