A swap that spells savings

Falling fixed-rate mortgage costs are a good barometer of the market place, says Stephen Pritchard

Home buyers usually have enough on their plates without going through the small print of their newspapers' financial columns. But if they did, they would find growing evidence that the end is in sight for mortgage rate rises.

Home buyers usually have enough on their plates without going through the small print of their newspapers' financial columns. But if they did, they would find growing evidence that the end is in sight for mortgage rate rises.

With City analysts predicting that the Bank of England will increase rates, perhaps as soon as next month, this might seem an odd assertion. But a study of the rates that banks use to borrow longer-term funds from each other - the swap rates - suggests that the worst is indeed behind us.

Ray Boulger, senior technical manager at the mortgage brokers Charcol, says that for the first time in almost a year swap rates are starting to fall month on month. Swap rates determine how much home buyers pay for fixed-rate mortgages, and lenders have already started to pass on the falls in the form of cheaper fixed rate deals.

Boulger says that the City now expects the current interest-rate cycle to peak at between 5.25 and 5.5 per cent, rather than the 5.5 to 5.75 per cent range that had been expected until recently. The Bank of England Governor Mervyn King's recent speech to the Confederation of British Industry (CBI) has, analysts believe, altered market expectations.

Fixed-rate mortgage costs are a good barometer of the market place, because swap rates are based on the City's expectations of future interest rate movements, while variable rates reflect the current base rate. The current five-year swap rate is at 5.5 per cent, and two-year swaps are at 5.37 per cent.

Any five- or two-year mortgage will be a good deal for home buyers, although the banks are canny enough to make sure they do not lose money. Arrangement and other fees, plus the chance to sell other financial services products to borrowers, will recoup any initial losses on interest rates. But as banks fight to win new business for fixed-rate loans, some might be tempted to offer cheaper rates as "loss leaders".

What borrowers will not see in the near future, market experts believe, are rates that are near, at or even below base rates. When interest rates were falling a few years ago, swap rates were below Bank base rates. This allowed lenders to price fixed-rate loans that were lower, in absolute terms, than variable rate arrangements.

This price trend attracted buyers to fixed-rate loans because they were cheaper, rather than because of the certainty they offer. This trend has changed, says Charcol's Boulger. Today's home buyer opting for a fixed rate is more likely to do so, so that they have complete certainty about their outgoings.

Not all borrowers stick with the idea of a fixed deal, once they understand the interest rate picture. Boulger says that when borrowers learn that fixed rates are now on a downward curve - even though base rates are still rising - they do often reconsider their options, rather than tie themselves in to today's rates.

Charcol's best fixed-rate deal for five years is 5.49 per cent. The broker also has a capped rate deal that can go no higher than 5.99 per cent, and is currently charging 0.75 per cent over base rates. This makes for a pay rate at the moment of 5.25 per cent, with relatively little risk if rates rise. "If base rates do fall by 2006, or even late 2005, you will get the benefit of rates coming down," he says.

But the way lenders price their mortgage deals means the picture is not always as clear as City expectations suggest. Boulger points out that some lenders will set aggressive prices for loans, in order to pull in new business and to meet shareholders' expectations. The lenders doing this changes from year to year, so shopping around is key.

Phillipa Gee, investment adviser at IFA firm Torquil Clark, notes that lenders are also changing the way they structure their interest rates on shorter and longer term fixed rate mortgages. Lenders are lowering their rates on shorter-term deals, making the longer-term fixes look dearer.

"It is fair to say that we have seen reductions by some lenders in short-term rates, however the knock on impact has been to raise longer fixed rates once more, making them less aggressively priced. What has always put people off is the wide variance between short and long term rates and as we are starting to see this widen even more, it doesn't spell out much hope for borrowers," she says.

But she adds that pure cash savings should not be the only reason for taking out a fixed rate.

"I believe that the demand for fixed rates shouldn't be driven by how high or low a rate is, but whether you are looking for absolute knowledge of how much your mortgage payments will be for a set period of time," she says.