How do you fancy a 30-year fix?

Mortgage rates are diving. They may follow the European market and go lower, or the American model and go longer, writes Isabel Berwick

Just how low can mortgage rates go? It's a vital question for thousands of homeowners who are coming to the end of a fixed-rate deal or are thinking about swapping to a cheaper loan. There are very good fixed-rate and discounted loans around, but it's also tempting to stick with variable rates because interest rates look set to drop further during 1999.

But if you took out a fixed-rate now, you would be stuck if mortgage rates went down to 3.5 per cent. Thousands of people have had their fingers burned by taking out five-year fixed-rate mortgages at 8 per cent or more in 1995 and 1996. Even a year ago, five-year fixed rates were selling for about 7.5 per cent. Now variable rates are as low as 5.99 per cent (Egg).

Some mortgage experts are convinced rates won't drop far below current levels and believe a new five-year fix is a good move. Simon Tyler, at Chase de Vere Mortgage Brokers in London says: "Five year rates have gone up since last month, but the average rate is 5.25 to 5.4 per cent. Even if we go into Europe, they won't be much cheaper than that.

"There are plenty of good deals around and most people we talk to want to fix their mortgage, although discounts are becoming more attractive."

The rates offered for fixed-rate mortgages reflects the current sentiment in the markets. Your lender puts together a swap deal to fix the rate for the mortgages and then hedges its own risk with other derivative deals. It's complicated and the markets change from day to day.

Adam Chester is chief economist for the Halifax Treasury department. He explains why five-year fixed rates have gone up slightly since January, despite the 0.5 per cent drop in the Bank of England interest rate: "How the market perceives inflation over the average life of the bond is key. We have a 5.3 per cent five-year swap deal at the moment. That can be broken down into a 2.5 per cent yield, a 2.5 per cent inflation expectation and a 0.3 per cent risk premium."

As recently as October 1998, the same type of swap deals carried interest rates 1.5 per cent higher than they are now. Rates will go up again if the markets start to worry that low interest rates will fuel a mini-boom and higher inflation.

Interest rates across euroland are set at 3 per cent. Fixed and variable mortgages in Europe are selling for 5 per cent.

But that could drop as lending is getting more competitive. Abbey National took the Italian market by storm last year by offering a variable rate deal at 5 per cent when most banks were selling fixed-rates at 7 per cent. The bank's variable rate in Italy is currently 4.98 per cent and it is offering a 10-year fix at 6.48 per cent.

Traditional high street lenders with high profit margins may struggle to offer us rates much below 5 per cent. But if you are undecided about whether to opt for a new fix or a variable rate, then you should also look at the new variable rate lenders such as Egg and Standard Life. They don't have expensive branch networks and they have massive cash reserves. Both companies are effectively buying customers through very attractive rates (see panel, right). If rates rise dramatically, you can always switch to a fix later on.

However, it may be that we are thinking about mortgages in completely the wrong way. Many American borrowers opt for 15- or 30-year fixed-rates for the whole life of the loan. Current deals are around the 7 per cent mark. US borrowers can also claim generous tax breaks which make the real interest rate closer to 4.5 per cent (our tiny MIRAS tax break could be scrapped altogether in the Budget next month). American borrowers can pay to swap to another long-term loan if rates plummet.

But the philosophical difference is that Americans look at buying a house as a long-term financing project, without getting obsessed with the ever- changing economic climate. Many US 30-year deals are securitised loans, meaning the lender bundles loans together and sells them to a third party as an income producing bond, with the income coming from mortgage payments.

We may start to see something like this starting here, as the Woolwich has announced a link with the US securitised lender Countrywide Credit Industries. This sort of lending should lead to a drop in rates and it should allow UK borrowers to fix their mortgage rates at a competitive level for the whole life of the loan.

HOW MUCH IS THAT MORTGAGE?

CHEAPEST VARIABLE RATES

n 5.99 per cent: Egg 0845 600 0290. Lends up to 90 per cent of the value of your home; gives you pounds 200 towards legal fees and offers free valuation.

n 6.05 per cent (4.55 per cent for the first six months): Standard Life 0845 845 8451. Lends up to 90 per cent of the value of your home; again, offers pounds 200 towards legal fees and free valuation.

SPECIAL DEALS

n Fix - 5.15 per cent for five years: Coventry BS 0345 665522. Six months' interest penalty for redemption before the end of the term.

n Discount - 1.65 per cent off standard rates for two years (currently 5.2 per cent). Rate capped at 5.99 per cent. Chase de Vere Mortgage Management 0171 930 7242.