Put a lid on rates before they rise too high

As borrowing costs increase again, Melanie Bien asks if it's time to switch to a fixed or discounted deal

Homeowners are under pressure to remortgage sooner rather than later, after the Bank of England's decision to raise the base rate last Thursday.

Homeowners are under pressure to remortgage sooner rather than later, after the Bank of England's decision to raise the base rate last Thursday.

While a quarter point rise - taking the base rate to 4.5 per cent - might not be significant in itself, it is the second one in as many months. This quicken- ing of the pace sends out worrying signals to homeowners.

"An extra £20 or so a month on the typical mortgage may not sound very much, but when it comes hard on the heels of a rise just four weeks ago, it starts to add up," says Peter Barrett of broker MyMortgageDirect.

According to broker Clear Cut Mortgages, repayments for a household with an outstanding loan of £100,000 have risen by £55.21 a month - £662.52 a year - since the Bank's Monetary Policy Committee (MPC) started hiking rates last November. There have been three increases since then.

"You have to ask yourself where we are going to be at the end of the year," says Mr Barrett. "The MPC has demonstrated that it is not afraid to use this brutal mechanism of cranking up rates. It would not surprise me if we end 2004 climb- ing above the 5 per cent mark."

Mr Barrett is not alone: many lenders and brokers now forecast that rates will be at least 5 per cent by the end of the year.

"This rise is unlikely to be the last," warns the Council of Mortgage Lenders. "Borrowers should arrange their finances to be able to cope with moderately higher rates over the coming year or so."

But the question is what course of action borrowers should take. Usually a fixed-rate deal over two, three or five years would protect homeowners against further rises. But many fixes are expensive as the rate increase was largely anticipated by the markets.

Clear Cut Mortgages says the best two-year fix is Britannia building society's 4.99 per cent, while mortgage broker London & Country says the best two-year discount is Newcastle building society's 4.05 per cent.

But David Hollingworth at London & Country argues that even though discounted rates might be cheaper, fixed deals still suit certain people. "They are expensive compared with what they were last July, but they aren't outrageously priced," he says. "And they are expensive compared to variable-rate deals. But when we test people's attitude to risk, some will be prepared to take a chance with a variable rate and others won't."

But he does recommend that if you want the certainty of a fix, you act quickly: "Don't hang around because fixed rates are rising all the time."

Simon Tyler at broker Chase de Vere Mortgage Management also reckons fixes are a sensible choice, particularly if you are on a tight budget. But he advises fixing for a short period. "Five-year deals are less good value and I also think that rates may start to fall again within the next two to three years, so they don't look very attractive. Those who can afford to see their payments rise could consider a discount or tracker deal."

For those who can handle some fluctuation in rates and prefer to make savings now, Mr Hollingworth recommends a two-year deal from mortgage lender Giraffe. The rate is capped at 5.25 per cent - so can't climb higher than this - but there is also a 1.4 per cent discount, giving borrowers an initial pay rate of 4.89 per cent.

If you are considering remortgaging, first check if you will incur redemption penalties for doing so. Some lenders charge a penalty even if you have come to the end of a fixed or discounted deal.

Even if you will have to pay a penalty for switching, it may still work out cheaper than sticking with your current loan. Contact an independent mortgage broker to find out whether this is the case.

FIXED UP

Ian and Kireen Rooney, 35 and 29 respectively, are breathing a sigh of relief. The couple, who live in Ruislip, Middlesex, are remortgaging their home from a capped to a fixed-rate deal.

From the end of this month, they will be on a two-year fix at 4.79 per cent with Nationwide. So last week's rate rise won't affect them.

The couple had been toying with remortgaging to a tracker deal. But they went for the fix at the last minute after talking to mortgage broker London & Country.

"We nearly took out a two-year tracker but I had a nagging doubt that rates would go up," says Mr Rooney, an accountant. "The broker pointed out that there would have to be four rises [of 0.25 per cent] in the base rate before we would be in trouble, but I thought that two years is a long time and even more rises could take place. We decided we wanted peace of mind."

The rate the Rooneys opted for is so competitive, it has since been withdrawn. "With hindsight, perhaps we should have opted for a five-year fix, but the two-year deal we got was the best offered by any lender at the time," says Mr Rooney. "I like to overpay on the mortgage each month, so this will let me do so safe in the knowledge that my actual repayments won't fluctuate for a couple of years."