Act now to avoid 'rate shock'

Take note of when a fixed-rate period is due to end - the bank won't do it for you, says Stephen Pritchard

Two years ago, mortgage rates were at a historic low. Bank of England base rates were at 3.75 per cent and bottomed out in July 2003 at 3.5 per cent. Today, rates stand at 4.75 per cent.

Two years ago, mortgage rates were at a historic low. Bank of England base rates were at 3.75 per cent and bottomed out in July 2003 at 3.5 per cent. Today, rates stand at 4.75 per cent.

Homebuyers who had the foresight to arrange a fixed-rate mortgage may have paid even less. Two years ago, Britannia Building Society offered two-year fixed rates for just 3.24 per cent.

Home owners who are now coming to the end of these deals face a large jump in their monthly payments. This "rate shock" can see the cost of a mortgage double, as a borrower moves automatically to the lender's standard variable interest rate (SVR). The average SVR is now 6.75 per cent.

Lenders have little or no incentive to remind borrowers that they will face a jump in repayments, as borrowers who pay the SVR help boost profits. As Ian Giles, frombrokers Purely Mortgages says, the banks' approach is very much to "let sleeping dogs lie... Lenders will leave borrowers on the standard variable rate until they complain, and then try to buy them off with a rate that is better, but not market-leading."

Often, the first time a home owner will notice that their rate has changed is when they check their bank balance; all too many borrowers ignore letters from mortgage companies as junk mail. There are still good deals on the market, but it is vital to act quickly. A home owner with a mortgage of £100,000 faces a jump of £130 a month if they move from a two-year fixed rate of 3.39 per cent to the current market-leading deal of 4.95 per cent, on offer from the Nationwide.

The mortgage broker Bradford & Bingley calculates, however, that if the same borrower moved to a typical standard variable rate of 6.75 per cent, they would pay £295 more each month. As many as 800,000 people could be affected by "rate shock" this year.

Ideally, borrowers should start looking for a new mortgage deal before their fixed rate ends to avoid higher payments. Even for home owners who do not want to tie themselves to another fixed rate, there are several attractive alternatives to staying on the lender's SVR.

At Bradford & Bingley, Duncan Pownall points out that an offset mortgage with the One Account is charging 4.3 per cent. There are no redemption penalties and home owners can cut their interest bills by keeping savings in the account, but the interest rate is variable.

There is also a good choice of discount and tracker mortgages on offer at the moment, at rates that are somewhat lower than the best two-year fixed rate deals. As Pownall points out, however, just a couple of base rate rises would make these loans more expensive than a new, two-year fixed rate. "It is more important for buyers to be comfortable with the type of loan than to go for the lowest price," he says.

Some home owners might not have this luxury, because they have already stretched themselves to the limit in order to raise a mortgage. A buyer who took advantage of highly attractive rates two years ago, and based their budget on that, could find that they will struggle to cover the cost of a new mortgage.

At mortgage brokers Charcol, Ray Boulger suggests that it is people who are older and further up the property ladder who might be hit hardest by "rate shock", rather than first time buyers - who are likely to have enjoyed pay rises over the last two years. Finding the cheapest mortgage possible will soften the blow. But in extreme cases, home owners might need either to make their money work very hard, or think about downsizing.

One short-term solution is to arrange a slightly higher mortgage and use the extra cash to meet repayments. Keeping the money in an offset account will cut the interest charges on the larger loan.

Borrowing an extra 10 per cent might be enough to tide a homeowner over until rates start to fall again, or they can move. But it is far from a permanent solution: they will end up paying more interest in the long run.