It ain't broke, but fix it anyway

Loan rates could rise dramatically over the next year. So what are the best options for homeowners?

Homeowners wishing to beat rising mortgage bills should act swiftly to switch into fixed-rate deals, because by this time next year these will be cheaper than the most attractively priced discounts currently available.

This is the somewhat surprising but unequivocal conclusion of research carried out by The Independent this week, the results of which have taken some mortgage lenders and brokers aback.

Loan rates are expected to rise by up to 2 per cent over the coming year, at a time when April's abolition of mortgage tax-relief jacks up monthly bills by nearly pounds 18 pounds.

Many homeowners are anxious to mitigate these bills, by switching to a fixed or discounted deal. Discounts, which start as low as 3.44 per cent with the Woolwich, initially seem to have the edge, as fixed rates hover nearer 6 per cent.

Yet when The Independent compiled research into monthly premiums on a range of the most competitive deals around, and studied how these would change as a result of any rise in interest rates, it revealed that borrowers who opted for a fixed rate would be popping champagne corks in a little over 12 months.

You need to move quickly: money- market rates, on which fixed deals are based, rose this week. Swap rates for a two-year deal are now priced at 6.96 per cent, three-year fixes cost 7.04 per cent, and five-years 6.92 per cent. Add the bank's margin of 1 per cent, and it is clear the next tranche of fixed deals will be nearer 8 per cent than 7 per cent.

Of course everything depends on just how high interest rates rise, and for how long. As there is no consensus among the three biggest lenders, borrowers must decide for themselves.

The Nationwide thinks they may reach 9 per cent by the end of next year, although it admits to being a touch pessimistic. The Abbey National thinks the gloom is overdone. It sees a peak of just 8 per cent. The Halifax indicates somewhere in between.

Lenders including the Abbey National, Standard Life, Northern Rock NatWest and Virgin announced mortgage-rate hikes earlier this week. Most major banks followed the Halifax and set a 6.99 per cent rate, although Standard Life came in at 6.1 per cent and Virgin at 6.35 per cent, while Northern Rock was the dearest at 7.05 per cent.

These rates can be cut by some very attractive discounts. However, borrowers should remember that with these deals their repayments will rise in line with any overall increase in borrowing costs, as well as the abolition of Miras. In some cases they may rise even faster, if discounts are clawed back.

Our research revealed, for example, that the cost of a two-year pounds 60,000 discounted Halifax loan, currently looking attractive at 4.13 per cent, will rise from pounds 314.16 to pounds 396.35 a month by the end of next year - if the Nationwide's forecast is right. Its two-year fixed deal, however, remains pegged at pounds 354.41.

If the Abbey is right on interest rates, the sums get closer, but even then fixed rates win out every time. A word of warning, though. These competitive Halifax rates have mortgage redemption penalties which last longer than the special deal. In other words you'll be stuck with the Halifax for some time to come.

The Abbey's deals listed in our table, left, do not have such onerous redemption penalties - which is why they look a little dearer. But borrowers could find them as cheap in the long run. Here too the cost of a five-year pounds 60,000 discounted deal could rise to anything up to pounds 429.05 by the end of 2000, while a fixed mortgage would be pegged at pounds 402.35 monthly.

Of course borrowers must also consider how long they expect rates to remain high, because early savings at the beginning of a discount can outweigh the benefits of a lower monthly payment if rates peak only briefly. Given how close these figures are, however, the extra safety of fixed-rate deals can only add to their attraction.

The chart topper among the fixed deals at the moment is a one-year steal from the Leeds & Holbeck, costing just 1.49 per cent. However, borrowers are tied to the society for a further four years.

The Abbey National and Halifax currently have among the cheapest fixed deals, although the Britannia has an interesting 10-year mortgage fixed at 6.59 per cent.

Capped loans are also back in fashion, although they are slightly more expensive than the fixes. The best deals currently come from the Nationwide, which will cap your rate at 6.59 per cent for two years, or from the Lambeth, which pegs your loan costs at 6.39 per cent for two years. Abbey National will put a ceiling on your interest for five years for 6.6 per cent; and the Royal Bank of Scotland will do it for three years at 6.75 per cent.

Borrowers with no deposit will find 100 per cent loans hard to come by. However, both Bristol & West and the Yorkshire Building Society will consider them, as will all the Scottish Banks, where these loans are the norm.