Oak Tree Mortgages Blog

The fixed rate dilema... is 2 years too short?

As any good cook will tell you, timing is everything. The same is true with fixed rate mortgages at the moment!

Imagine you want a mortgage that allows you to budget for the next few years. You might be unsure which way interest rates are heading and you don't like nasty suprises. It's important that you know how much your mortgage payments are. After chatting through your mortgage requirements with an adviser, you decide a fixed rate matches your needs.

You've decided to stretch yourself a bit to get a nicer home, maybe with an extra bedroom or a bit more space downstairs. You can see yourself staying there for at least 5 years.

If you want a fixed rate, how long should you fix for?

You will probably look at 2, 3 or 5 year fixed rates. You might be tempted to go for a shorter 2 year rate for two reasons...

The rate may be (but is not always) lower over a shorter period of time AND you might want to 'review' your mortgage again in 2 years time.

Of course, in times past, shopping around again for a mortgage every couple of years could prove lucrative. Beware, 2 year rates may lead to some very nasty suprises in 2 years time!

Consider what the Bank of England forecasts are for economic growth over the next couple of years. Billions upon billions of pounds, dollars, yen and euro's are being pumped into the global economy to fend off the recession by governments across the globe. Whilst we are all experiencing pain in the shorter term, in time economic growth will return.

As previously mentioned in our blog, it is our opinion that the Bank of England base rate will rise in the medium term. Just to repeat why we feel this...

Firstly, low rates have not helped savers who have withdrawn their savings from British banks to find a better rate of return elsewhere. This has left the banks with even less money to lend.

Secondly, the low exchange rate is leading to the price of imports increasing, which, in time will lead to higher prices in the shops (and higher inflation). This problem will be especially acute once the economy pulls away from recession.

The Bank of England will try to tackle these problems, when it is safe to do so, through increasing the bank base rate.

How will that effect you if you have chosen a 2 year fixed rate?

In our opinion; at the exact point a 2 year fixed rate comes to an end, interest rates could have already been increased to counter the threat of inflation and to halt the flow of savings out of the UK.

In two years time;

• How will you fair trying to renegiotiate a new interest rate at a time when interest rates could be increasing?

• Will the effects of the 'credit crunch' mean the mortgage market lacks competion at the point you are trying to find a new mortgage?

• What if property prices have fallen a little bit more over the course of 2009? If you started your fixed rate with say a 10% deposit, and your equity has been eroded by further falls in property prices, how likely is it that you will be able to find a new mortgage as your deposit has shrunk?

Very careful consideration needs to be given to these points before deciding the length of any fixed rate. None of us can be certain what is going to happen over the five years. Taking a shorter term rate exposes you to the risks that the next couple of years are likely to bring. Just as we are starting to think about our homes as somewhere we may have to live for a little longer than we would have done in the past, maybe now is the time to take the same view with our mortgage?

A cut too far?

The Building Society Association (BSA), representing the interests of the remaining building societies in the United Kingdom, warned today that they wish to see no further rate cuts from the Bank of England

As I have mentioned before - as the Bank of England cut interest rates to try and lower the cost of borrowing (with only limited effect); savers have found their savings rates slashed!

This is a real problem to Building Societies and other lenders. Savers place money on deposit with a bank or building society, who then lend out. This is how credit is created in a balanced economy.

Savers are now looking for a new home for their savings. British banks and building societies now offer very low savings rates. As a consequence, savers are placing money on deposit at foreign banks such as the Dutch bank, ING. This is making things worse for British lenders who are already short of money. Low rates will further damage the supply of credit. We believe in turn that this makes the low rates we will see in 2009 unsustainable.

As the lenders themselves start to warn against further rate cuts; borrowers who are "sitting on the fence" and are waiting for further rate cuts should take note. We await the Bank of England response which is due this Thursday.

UPDATE 24/2/2009

For many, it came as no surprise that the Bank of England base rate was cut further. Despite warnings from the lenders themselves that further rate cuts would have little or no effect on new borrowing rates. The minutes of the last Bank of England meeting suggest the Bank are going to look at other measures to help the economy and lending. In particular, they will be using a measure called 'quantitative easing'to increase the amount of cash in the economy. It is hoped that by flooding banks with cash, interest rates charged by lenders will ease and, at the very least, the amount of lending will increase. I think March will be a very interesting month as we see something other than rate cuts being utilised which will set the tone for mortgage lending for the rest of the year.

http://news.bbc.co.uk/1/hi/programmes/the_daily_politics/7925669.stm