Bargain buys to sweep the timid off their feet

we look at the state of the housing market and ask whether the optimism shown by mortgage lenders this year is really justified

BRITISH home buyers have become nervous creatures. Where once they roamed the land snapping up every broom cupboard with pretensions to be a studio flat, now they can scarcely be tempted into the open with the offer of free money.

Free money? It is true, twice over. Building societies and other lenders will give you part of your loan as cash if only you are kind enough to borrow. Others will charge you interest at less than 1 per cent for the first year of the mortgage, far less than it costs them to provide the loan.

"Cash-back" schemes and deeply discounted interest rates are just two of the inducements lenders have turned to in their efforts to find something, anything, to stir house buyers.

This continuing failure to stimulate enthusiasm is good news for those who still want to own their own home because, from any perspective, there has never been a better time to look for a mortgage. Many lenders are offering deals that will cover, or substantially reduce, the costs of remortgaging to a cheaper interest rate. Remortgaging can produce big savings. Phillip Cartwright, of London & Country Mortgages, a mortgage broking firm in Bath, says a 1 per cent reduction in the interest charge on a typical pounds 60,000 mortgage will, over five years, save borrowers nearly pounds 3,000.

Regardless of the ever-increasing range of bells and whistles that are attached to the modern mortgage, prospective borrowers essentially have a choice between three kinds of loan (as opposed to repayment vehicles - covered on page 18): variable rate, fixed rate and discounted rate.

The variable rate mortgage is the traditional option, the mortgage our parents knew. With a variable rate loan, the interest rate fluctuates in line with bank base rate, which is determined by government policy.

It is out of favour amid the clamour from the more complicated newcomers but still has its merits. In particular, home buyers will not normally be charged an application fee for taking out the loan, and they will not have to pay a penalty if they pay off their mortgage ahead of schedule. The drawback is that borrowers are exposed to sudden rises in interest rates, which can mean trouble.

Fixed rate mortgages put an end to that uncertainty. With a fixed rate, you know precisely how much you have to pay each month for the duration of the "fix". This can be as short as one year, is usually about five years, and can be 10 years or longer. Lenders are increasingly willing to let you take a fixed rate mortgage with you, should you decide to move to a new home. They may also offer you a new fixed rate when your first expires.

Prospective borrowers will typically be charged a fee to apply for a fixed rate loan, although these days that may be waived. You will have to pay the application fee even if you decide not to proceed with the loan.

A more important disadvantage is the penalty borrowers face if they pay off the loan early. The penalty is often six months' interest at the fixed rate. Fixed rate borrowers will also miss out on any fall in interest rate that occurs during the fixed period.

Discounted rate mortgages allow borrowers to pay a lower interest rate for an initial period. The rate can fluctuate but it is reduced by a set amount. As Your Money's Best Borrowing Rates table on page 22 shows, Scarborough Building Society is offering a 6.4 per cent discount for a year, reducing the initial interest rate to only 1.09 per cent. Smaller discounts of 1 or 2 per cent over longer periods are more common.

A discounted mortgage allows you to save money when you have just moved into your new home, but the problem is the hefty penalties you face if you decide to repay or switch your mortgage to another lender. Mortgage borrowers will also still feel the impact of interest rate increases, albeit mitigated by the discount.

The detailed terms of seemingly attractive mortgages may not suit your circumstances. For example, Hinckley & Rugby Building Society's offer of a 0.5 per cent loan fixed for one year is no use to you if you need to borrow more than 70 per cent of the cost of the property.

It is important to remember that with many fixed and discounted rate mortgages the penalty period, typically five years, extends beyond the fixed or discounted rate period. This means that even after your cheap loan has come to an end, you will still be locked into the same lender, paying the ordinary variable rate. With an election and a possible change of government in the next 18 months, this may entail more risk than you are happy to accept.

Mr Cartwright says: "People are attracted by very low fixed rates but are not aware that they are locked in for another three years on the variable rate. We do not want people coming back in three, four or five years' time saying, 'we weren't expecting this, we can't afford the mortgage'."

Mr Cartwright says that, in this light, the two and three-year fixed rate loans available from Cheltenham & Gloucester look attractive. But at 6.29 per cent and 6.75 per cent its rates are not the cheapest on the market, though borrowers are not tied in and are free to remortgage again after the end of the fixed-rate period.

Mr Cartwright says that for borrowers who are worried about rising interest rates "a five-year fixed rate loan makes a hell of a lot of sense". A further option comes from John Charcol, another firm of mortgage brokers. It has devised an "election-beating" mortgage that offers a 3 per cent discount for one year, cashback of 3 per cent of the loan and the option to switch into a five-year fixed rate within a month of the next general election being called. This is a good example of the ingenuity you will find in today's mortgage market.