The Chaos of Fixed-Rate Mortgages: Three Alternatives to Blocking a Costly Deal

Fixed-rate mortgage deals surged in the wake of the disastrous mini-budget, and while some homeowners rushed to foreclosure, others secured alternative mortgage deals.

This time last year, two-year fixed mortgage rates averaged 2.29%, while five-year transactions for all loan-to-value transactions were recorded at 2.59%.

Today, homeowners considering the same fixed rates can expect to pay significantly more, as bid prices average 6.35% and 6.12%, according to data from Moneyfacts.

They rose sharply following September’s ill-fated mini-budget with its series of stealthy – and unfunded – tax cuts that rattled markets.

As the two-year rate has fallen from last month’s peak of 6.65% and five-year rates from 6.51%, many new homeowners and those paying down are likely to experience a price shock. , especially for those coming out of better buy offers two or three years ago, which hovered around the 1% mark.

As brokers saw an influx of inquiries and watched landlords do the ‘unthinkable’ of ending their contracts early and paying a hefty penalty to do so to lock in rates before they are expected to rise further, for others they have noticed a resurgence in mortgage alternatives.

Here are three alternatives to fixed rate mortgages:

Mortgage tracking

As the name suggests, a trailing mortgage follows the Bank of England base rate, usually at a set margin above this amount, LDN finance Explain.

Compared to a fixed rate mortgage, there are no fixed monthly payments, as they can increase or decrease depending on changes in the bank rate. Borrowers typically sign up for two-year or lifetime follow-up offers.

According to LDNfinance, trailing rates can potentially offer a lower initial rate and monthly payment than a fixed rate and can also provide increased flexibility for the borrower in terms of overpayments and prepayment charges (ERC).

According to Moneyfacts, the average two-year follow-up rate is 4.12%, well below the equivalent two-year fixed mortgage deal.

And a scan of October data by Twenty7Tec reveals that, while the total number of searches for fixed products fell during the month, search volumes for mortgages increased by more than 50%.

This is echoed by Mike Staton, Director of Staton Mortgages, who says, “We have seen a significant increase in the number of follow-on mortgages being taken out by customers; these customers want flexibility at the moment rather than stability.

He reveals that his company has seen “75% of massive follow-up activity in the last month” when previously he was seeing about one case every three months.

“We’re in an era where ‘fixed rates are best’, maybe for 10 years, where interest rates have been historically low,” he says, adding that as trailing rates start at 3% , it was “easy to see” the call.

Staton explains that they’re typically used by those who may be moving in the near future and can get out of a deal without penalty.

“A tracker gives you flexibility now that fixed rates aren’t attractive enough anymore and are for people who think interest rates will go down.”

He gives the example of the Barclays tracker of 0.75% above the base rate, therefore 3.75%. “When you compare it to the 6% plus fixed rate offerings, it’s phenomenal.”

However, Staton was able to take advantage of an exclusive two-year trailing deal at 2.94% for a landlord with a property worth £500,000 and an outstanding mortgage balance of £110,000 over a 17-year term. . This customer would pay £685 per month over the two-year period, compared to £822 on 5.35% over two years, a difference of over £130 per month.

Staton shares his view that “in 18 months the base rate will go down, so tracker customers will be winners.”

However, he cautions that trackers come with an element of risk, especially if the discount rate were to rise.

“Be careful as not all trackers are penalty free and some come with small rules which, if not followed, could force you to stay with that lender for the long term.”

Compensatory mortgages

An offset links a mortgage to your savings, and your savings balance is used to reduce the amount of interest charged on the mortgage.

This means that borrowers only pay interest on the mortgage balance minus their savings balance. The savings don’t pay off the mortgage, but they stay on the side and save interest.

For example, if you had £100,000 in savings and an offsetting mortgage of £150,000, you would only pay interest on £50,000.

Like trackers, brokers have reported renewed interest in these products, especially as households have accumulated savings during the pandemic, which can now be put to good use, especially when the balance pays off. little or no interest.

Scott Taylor-Barr, financial advisor at Carl Summers Financial Services, says, “Compensating mortgages are a great, if very underrated, financial planning tool. Using your savings to help reduce the interest paid on your mortgage, while having full access to savings if you need them, is a very powerful way to use your money.

Jonathan Stinton of the Coventry Building Society says there was an assumption that compensatory mortgages ‘only work for big earners and big savers’, but that hasn’t always been the case.

“While it is true that offset is generally attractive to this type of customer, the products are not designed exclusively for them. Customers at the other end of the scale, with lower mortgage balances and less savings, could still see their money working harder for them with an offset product,” he says.

However, a downside is that there aren’t too many offset mortgages on the market. According to Criteria Brain, there are nine lenders who can offer a residential compensatory mortgage and two who can offer a buy-to-let compensatory mortgage.

Jonathan Burridge, founding adviser of We Are Money, explains that part of the problem with these products is that they are often “premiumly priced” and when you compare the offset savings against standard products, “there is very little in it”.

But a number of brokers say that with rising interest rates, there could be a strong demand for them over the next few years.

Riz Malik, Director of R3 Mortgages, says, “Given the growing gap between borrowing costs and the return on savings, compensatory mortgages may become popular again for those with large savings balances.

“The benefit of offsetting is that you can enjoy savings on your mortgage without losing access to funds. of your mortgage.

Chris Sykes, Technical Manager at Private Finance, gave details of a recent client who needed £500,000 to buy a property and wanted to borrow a further £250,000 for work on the property over the next two years. They needed instant access to funds, but the 5% interest would mean it would cost them £12,500 a year if they weren’t compensated.

Discount Mortgages

While trackers follow the Bank of England base rate, discount mortgages have a variable rate and a discount on that rate. For example, you might have a variable rate of 5.89% and a reduction of 2.9% on it.

The big difference here, according to Staton, is that the variable rate “can go up or down at the lender’s discretion,” so they can raise the standard variable whenever they want.

Staton says these products are more suited to “adventurous attitudes” as with the Bank of England “you know where you stand”, but with these variable rates “they go up and down at the discretion of the lender”.

He says that over the past two months these rates have been increased but on the basis of the client with the £500,000 property with an outstanding £110,000 mortgage this is one of the lowest mortgages expensive ones on the market – a 2.99% discounted offer that would see them pay £687 a month over two years, with a fee of £499.

However, he warns: “There is no guarantee that it will be the cheapest tomorrow”.

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