How to make sense of the mortgage market

The global credit crisis has hit the UK home loan market too

Although the global credit crisis began several months ago – principally because a handful of US banks had lent too freely to people with poor credit ratings – the fall-out has finally spread to the mainstream UK mortgage market over the past few weeks, with some lenders forced to raise their interest rates and even withdraw some of their higher risk products.

Over the last fortnight, Halifax, Abbey and Alliance & Leicester have all raised the rates for new borrowers taking out one of their tracker mortgages – by between 0.1 and 0.2 percentage points – while ING Direct raised its variable rate by 0.25 percentage points on Thursday, responding to the sharp increase in the rates at which the banks lend to each other on a short-term basis, known as Libor (London Interbank Offered Rate).

At the same time, the price of fixed-rate mortgages, which are financed from the longer-term Swap markets, have been falling. Swap rates are more closely linked to anticipated movements in the Bank of England's base rate – and after recent falls in inflation, combined with the potentially damaging effects of the credit crunch – investors believe that the next movement in the base rate will be downwards.

However, David Hollingworth, of the fee-free mortgage broker London & Country, points out that some lenders may have been slightly slower to reduce their fixed rates due to slightly uncertain conditions ahead.

"There's still scope for other lenders to cut their fixed rates," he says. "But you could see some lenders lagging because they want to reign in the amount of business they are doing, and are happy to stay out of the best buy tables."

At the same time, some lenders have begun to pull away from lending too much, relative to the value of the property – even to people who have gold-plated credit ratings.

Hollingworth notes that Norwich & Peterborough Building Society withdrew its range of 95 and 100 per cent mortgages last week – and will now only lend up to 90 per cent of the value of the property being bought. While Accord Mortgages withdrew their 115 and 100 per cent loans.

It's not all one-way traffic, however. Abbey launched a new 100 per cent mortgage last week, packaged together with a £25,000 secured loan – targeting first-time buyers who have no deposit and need to raise some extra money to pay for their start-up and legal costs.

Ray Boulger of the mortgage broker John Charcol says he believes that while loans of 100 per cent or more are not likely to dry up, they could become more expensive, as some lenders take the decision to pull back from the market due to the current climate.

"At the moment, there are still plenty of lenders in that market," he says. "But a few are pulling out, so with less competition the cost of these mortgages may go up. But I don't think we'll get to a point where you won't be able to get any of these products."

Abbey has come under some criticism for launching a product that will cast many borrowers into negative equity from the moment they buy their property. "Not only is the interest rate you pay higher," says Jenny Challenor, mortgage strategist at Torquil Clark, the financial advisers. "But if house prices fall, you will be plunged even further into negative equity – it is migraine inducing."

Abbey claims that it is just trying to provide first-timers with the means to get a foot on the ladder if they want to – and is only piloting the product with a few brokers.

"The main thing is to make sure you can afford it – whether you're borrowing 50 or 150 per cent of the value of the property," says Boulger. "But obviously, if you've got a much higher loan to property value (LTV), then if things go wrong, your options are much more limited."

Fixed or variable?

If you're not in need of a huge loan, relative to the value of your property, you'll have much greater choice about which mortgage provider to go with.

However, with short and long-term rates moving in opposite directions, deciding whether to opt for a fixed or variable rate can be tricky.

Boulger says: "My general advice is that people who can afford to take a view on the market, and do not need the certainty of a fix, would be wise to go for a tracker at the moment."

He adds: "Fixed rates have further to fall, so you may not be getting the best possible deal at the moment. And if you're in a tracker and the base rate comes down, then you're going to end up with cheaper payments."

Boulger says that it's also worth resisting the lower headline rates that you might get from a discounted mortgage.

Discount mortgages are linked to the lender's Standard Variable Rate (SVR) – which will vary according to your bank's commercial needs. Tracker mortgages, however, are linked to the Bank of England base rate, which is expected to fall over the next year.

"If Libor stays high for a period of time, there is a danger that some lenders will put up their SVRs," explains Boulger. "And if base rates come down, there is also a risk that some banks will not reduce their SVRs – to make up for some of the additional costs of the past few weeks."

Boulger adds that the best option for those who want to keep their options open, is to plump for a tracker deal that allows you to switch into a fixed rate at any time.

Charges

Before you pick your mortgage, it's important to cast a very close eye over the charges. While the headline interest rate may be attractive, the fees on different products can vary enormously. Furthermore, some lenders offer free valuations and legal fees, which can be worth an extra £600 or more.

Francis Ghiloni of mform.co.uk, the online mortgage broker, warns that there is also a worrying new tendency for lenders to charge non-refundable application processing fees, which they will keep even if you are turned down for a mortgage.

"It would be far more helpful for consumers if lenders would admit that they needed to charge more, rather than competing on price and then trying to sneak in fees to increase their margins," he says. "As it is, consumers need to look carefully at the total cost of the mortgage over the term of the deal."

For example, Britannia currently offers one of the most competitive two-year fixed rate deals, with an interest rate of 5.49 per cent, and a fee of £999. However, Woolwich's two-year fix at 5.59 per cent, may work out cheaper for most people, as it also includes free legal work and free valuation. Only those with very large mortgages would get a sufficient saving from the 0.1 percentage point differential.

It's not just application fees and freebies that you need to watch out for either. Ask your lender to explain every possible charge you may be hit for.

To find a mortgage broker in your area, visit www.impartial.co.uk or call 0800 085 3250