Should You Ditch That Fixed Rate Mortgage?

With the base rate falling, and more cuts being hinted at, could you save money by remortgaging, even after paying any charges?

I don't know about you, but I was pretty shocked by the Bank of England's decision to cut interest rates by 1.5%, at the start of the month. The base rate currently standing at just 3%, its lowest level since 1955 -- and there have been hints that there may be more cuts in the base rate to come.

Great news for those of you on variable rates -- and also, for those of you who need to remortgage now. You can switch to a tracker or discount mortgage and benefit from any future falls.

But what about those of you who signed up to a fixed rate deal a few months ago when rates were much higher, and are now tied in for two years or more? Could you save money by ditching that mortgage and signing up to a new, cheaper deal?

Your immediate thought is probably that this is a terrible idea. After all, mortgage lenders dish out hefty penalties (in the form of Early Repayment Charges or 'ERCs') to discourage us from switching out of fixed rate deals. Plus remortgaging is far from cheap, with arrangement fees of £2k+ being quoted for some of the best deals.

And bear in mind that most trackers now are only available if you have a 25% deposit or equity stake in your property. So if you have a small deposit, it probably isn't worth switching.

But what if you do have a deposit of 25% or more? Could you save money by switching, even taking into account the fees and penalties?

Example

Say, for example, Tom had remortgaged last month to a 2-year, fixed rate, 20-year repayment mortgage at 6.5%AER. He borrowed £225k, has 25% equity in his home and is currently paying £1,667 per month.

He spots a three-year tracker with Cheltenham & Gloucester, at 5.05%AER, with a product fee of £1,094, £500 legal fees and a free valuation. He uses the Fool's mortgage calculator and works out that should he switch to the deal he would be paying £1,497 per month, a saving of £192.64 per month.

Of course, he needs to take into account the 2% exit fee payable to his current mortgage provider (£4,500) and the £1,594 arrangement fee to the new lender. So that's £6,094 in fees. Ouch!

But even after all of this, if the base rate remained at its current level for the next three years, he would still be around £841 better off.

And if the base rate falls a further 1%, as it is widely expected to, his payments will drop even further - to £1,376.05 a month. That would mean a saving of £308.15 a month.

If the base rate remained at around 2% for the next three years, he would end up more than £5,000 better off because he had switched.

40% Deposit

What's more, if Tom had 40% equity in his home the potential savings are even greater. HSBC is currently offering a Term Tracker deal at 4.64%AER with a £799 arrangement fee, available only to those with a 40% deposit. Monthly payments in this case would be £1,416, saving £261 per month.

Even after the £5,299-worth of fees and charges have been taken into account, he would save around £4,000 over three years. And that's if interest rates remain at 3%.

If the base rate falls a further 1%, his payments would again drop massively - to £1,327 a month. That's a saving of more than £350 a month.

In this case, after the £5,299-worth of fees and charges have been paid, he would save more than £7,000!

But that's only if the base rate falls to 2%, and remains that low for three years.

Risks and rewards

The risk with this strategy is that, while falls are predicted, no one can know for sure what's going to happen to the base rate. It could increase dramatically. So this is a risk Tom would have to be prepared to take. Alternatively, he can stay on his fixed rate deal with the secure knowledge that his monthly payments will not fluctuate, no matter what happens to the base rate.

But anyway, never mind Tom - what about you? To figure out whether you would benefit from switching, use the Fool's mortgage calculator to find out how much your monthly payments would be on a new deal (such as those mentioned above). Then multiply this monthly saving by the number of months you would be on this deal (so multiply by 24 if it's a two-year deal). This is how much you could save - if you didn't have to pay any charges.

So unfortunately you must then deduct any early repayment charges (typically around 2%) and the product fees on the new deal. Then, you've got the correct figure - this is how much you would save by switching.

If you're considering switching to a tracker, you could then also try dropping the rate by 1% to see how a fall in the base rate would affect your payments/savings.

Finally, before you do anything, check when you first took out your current deal. Some lenders also have tiered exit fees - so if the deal you are on is coming up to its anniversary, it could be worth waiting to see if your early repayment charges will reduce in a few weeks' time.

Good luck!

More: Mind This Mortgage Trap