The secret way your mortgage lender steals from you

A price war is breaking out in the mortgage market as lenders rush to cut the price of fixed-rate deals - just as an influential think tank issues an apocalyptic warning over future interest rate rises. So is it now the time to fix your mortgage? Mark Adams assesses the market.

The average cost of a fixed-rate mortgage has fallen sharply this month with a number of lenders moving to cut their rates - despite the Bank of England keeping the official cost of borrowing at 0.5% for the sixteenth month in a row.

Mortgage giant HSBC kicked-off the price war last month with the launch of its five-year fixed-rate deal priced at just 3.95% - available to buyers with a deposit of 40% or more, with a low ‘booking fee’ of £599.

Other lenders - including Nationwide, the Post Office and Yorkshire Building Society - responded this month with price cuts of their own. What’s more, many of these new offers are open to first-time buyers and borrowers with smaller deposits.

So what’s changed in the mortgage market? And is it worth paying a premium for the security fixed-rate deals offer - or should you bank on interest rates staying at their record low level for the foreseeable future?

Why fixed rates are falling

It’s worth remembering that banks enjoy far higher margins on fixed-rate deals than on any other type of mortgage - and that their profits have taken a battering following the emergency interest rate cuts of the past two years.  But now, following sharp falls in inter-bank lending rates, it seems the big banks are restoring their margins.

Figures from analysts Moneyfacts show that profit margins on fixed-rate deals - even after the recent round of price cuts - are at an all-time high.  Two years ago the margin on a two year fixed deal stood at 1.28%. Today the average rate is 3.29%.

That means, on average, mortgage lenders today are stealing an extra £150 from you for every £150,000 you borrow.

The figures highlight the extent to which borrowers are being ripped off by the banks for trying to protect their mortgage repayments from interest rate fluctuations - and the extent to which banks are raking it in while interest rates are low.

Why it’s still worth fixing

When you consider that the margin on the current best buy discount tracker mortgage - HSBC’s lifetime tracker at 2.19% - is just 1.69%, you could be forgiven for thinking it’s not worth fixing.  Yet, with base rate at near-zero, it could still be worth paying the additional premium - particularly if you believe the latest predictions over the future direction of interest rates.

The most startling forecast was issued this week by right-wing think tank Policy Exchange. It claims that interest rates could soar to a staggering 8% inside just two years to help combat sharp rises in inflation as the UK economy exits recession more slowly than expected. If the prediction comes true, the rise would add more than £900 in interest to the average monthly repayment on a £150,000 mortgage.

Scary stuff - but fortunately other predictions are less alarming, even if inflation remains a problem. The latest regular monthly Reuters poll of 50 leading economists predicted that rates wouldn’t rise until April 2011 and then continue a slow climb to 1.5% by the end of 2011.

Rates will rise more slowly, they argue, because the recovery remains too weak to withstand any measures aimed at curbing consumer spending. It’s hard to say who’s right - but next month’s inflation report from the Bank of England will certainly make interesting reading.

How to decide

Whether to fix or track your mortgage is one of the toughest questions to answer but fortunately you don’t need to be an economics professor to come to a decision. Bear in mind that interest rates can’t realistically fall any lower and will have to rise at some point over the next 12 months.

Think about what you can realistically afford to repay each month. If a series of interest rate rises would leave you struggling to cover your current mortgage, you may want to fix at a comparatively lower rate now - particularly as the economic consensus at least seems to suggest that house prices will remain at their current level for some time, meaning you won’t lose out in real terms.  

Best buy fixes

Average margins on fixed-rate deals may suggest that tracker mortgages currently offer better value - but when it comes to the best buys fixes look much more competitive. For ultimate peace of mind, you’ll want to head to for a five-year deal. The best on the market is the HSBC 3.95% fix mentioned above - but if you don’t have 40% equity you’ll need to look elsewhere.

Yorkshire Building Society has dropped its five-year fix rate to 3.99% and the deal is open to borrowers with deposits of 25% or more. The Yorkshire mortgage was previously priced at 4.19% but now the product fee has nearly doubled to £995 (although it can be rolled into the mortgage as whole). Alternatively, you can fix with First Direct for 4.19% and pay a lower fee of £99 (LTV = 65%).

A two-year fix offers less security but will allow you to adopt a “wait and see” approach. Among the best buys is the recently reduced purchase deal from the Post Office at 2.85%, available with a deposit of 35% or more and fees totalling £1,495. If you prefer to exchange a lower fee for a slightly higher rate, look to the two-year fix from Yorkshire Building Society at 2.99% with fees totalling 4.95%, open to borrowers with deposits of 25% or more.

Find the right deal for your needs with our free personal mortgage search and make it your goal to cut your mortgage costs and pay off your mortgage early.

Compare mortgages at lovemoney.com

More: The greatest threat to mortgage holders | The 2.6% mortgage trick

At lovemoney.com, you can research all the best deals yourself using our online mortgage service, or speak directly to a whole-of-market, fee-free lovemoney.com broker. Call 0800 804 8045 or email mortgages@lovemoney.com for more help.

This article aims to give information, not advice. Always do your own research and/or seek out advice from an FSA-regulated broker (such as one of our brokers here at lovemoney.com), before acting on anything contained in this article. 

Finally, we tend to only give the initial rate of a deal in our articles, but any deal which lasts for a shorter period than your mortgage term may revert to the lender's standard variable rate or a tracker rate when the deal ends. Before you take out a deal, you should always try to find out from your lender what its standard variable rate is and how it will be determined in the future. Make sure you take all this information into account when comparing different deals.

Your home or property may be repossessed if you do not keep up repayments on your mortgage.