Is it time to ditch the fix?

Should borrowers with long-term fixed mortgages ditch their deals?

Borrowers that signed up for long-term fixed-rate mortgatges in the past year or two have been left counting the cost as interest rates have fallen. But what should they do: Stick with their current deal or pay the early redemption charges and remortgage to a better interest rate?

One of my friends called me for some mortgage advice the other day. He and his girlfriend had signed up for a 5.98% fixed rate for five years a year ago when they bought their first home. Since then rates have tumbled and smug people like me on trackers are paying ridiculously low rates. Keen to cut costs, my friend wanted to know whether it was worth paying to get out of their existing deal and remortgaging to a cheaper rate.

He's not alone and, despite having another four years of his fixed deal to go, he's in a better position than some people.  

Back in 2007 the Government was keen to get people to commit to 25-year fixes. Both Gordon Brown and Alistair Darling urged people to take up a long-term fixed rate.  Borrowers who took the long-term plunge and committed to a lifetime rate two years ago will be paying around 5.98% for their mortgage. But falling interest rates and a base rate of 1% mean you can now pick up a two-year fix at less than 4% if you have a decent deposit.

The case for ditching

The Bank of England base rate is at an all-time low at the moment at 1%. Some lenders are offering trackers with current pay rates of around 3.31%. If you meet HSBC's strict eligibility criteria you can pick up a two-year fix at 2.99% while First Direct has a lifetime tracker with a current pay rate of 2.89%.

In some cases it will be worth exiting your current deal to move on to one of these products but you need to do your sums first.

Most mortgages come with early repayment (or redemption) charges, often referred to as ERCs. These kick in if you pay off your loan - which includes remortgaging to another lender - before the end of the tied-in period.

So if you have a five-year fix you'll probably be subject to ERCs for five years. ERCs are normally a percentage of the loan amount. As well as ERCs you need to factor in the cost of setting up your new mortgage and this will include arrangement, valuation and legal fees. This calculator could help you decide whether switching is a good idea or not.

When Halifax launched its 25-year fix in August 2007 the deal, fixed at 6.39%, came with a relatively high ERC at 3% of the loan and the penalty applied to those who switched mortgages in the first 10 years of the loan.

I put an example in the calculator. I assumed that a woman had a £200,000, Halifax 25-year fixed-rate mortgage with eight years until the ERCs finished. She wanted to add the charge to her new loan (rather than paying it upfront.) According to the calculator, she would need a new loan with a mortgage at 5.84% or lower if she was to make money. (That's assuming the remortgage costs were paid for by the lender. The rate would need to be 5.79% if the borrower paid the remortgage costs.)

Assuming the borrower had a decent credit history and 40% equity in their property, finding a deal below this rate should be relatively easy.

The case for sticking

In some cases the figures simply won't add up, especially if you have a small-ish mortgage. For example,  if you have a £100,000 mortgage at 5.5% and are subject to ERCs for two years at 3% and plan to add them to your new loan, then you'll need to secure a rate of 3.88% or less if the new lender pays your remortgage costs or 3.5% if you pay them yourself.

With the average two-year fix now standing at 3.93% and average three-year deal at 4.73% you'll be hard pushed to find a deal which makes the switch worthwhile.

Other homeowners will find it won't be worth switching as they're not eligible for the best deals. Going back to the example of my friend, he and his partner borrowed about 85% of their property's value when they bought it last year. The house cost £150,000 and so they borrowed £127,500.

Let's say it's fallen in value by a modest 10% over the past year so it's now worth £135,000. If they keep their home loan size the same, they'll need to borrow almost 95% of their property's value (£127,500 is 94.4% of £135,000).

But at the moment the best deals are reserved for people with a loan-to-value (LTV) of 60% or less. Homeowners needing to borrow over 80% of their property's value will struggle to get a decent deal while those needing to borrow 95% will find it virtually impossible. So, unfortunately, my friend has little choice but to stick with the mortgage he signed up for last year.

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