The new mortgage that charges less than Base Rate!

Is a homeloan that charges just 0.49% interest too good to be true?

News that Lloyds TSB is increasing its standard variable rate (SVR) for new customers is another terrible blow for first-time buyers.

It means that while existing customers will continue to benefit from Lloyds' ultra low SVR of Base Rate plus 2%, from the 1 June, new borrowers will revert to a higher SVR of Base Rate plus 3.49%.

But could there be a glimmer of hope on the horizon for first-time buyers? A new deal has been launched which offers first-time buyers a rate below the Base Rate.

I'm sure you already know why this is a big deal - because the Bank of England’s Base Rate is at a record low of 0.5%. It’s been there since last March and it’s been a boon for existing variable rate mortgage borrowers, who have seen their pay rates, and their monthly repayments, slashed over the past 14 months, meaning many are paying far less than they ever expected possible.

This is because variable rates -- such as trackers, discounted variable rates and standard variable rates -- are directly or indirectly linked to the Base Rate.

But these mega-low deals have been enjoyed by those who got a mortgage before interest rates fell. First-time buyers, unfortunately, were not invited to join the party!

Having said that, new deals available to first-time buyers or switchers are still very low when compared with the last five years, but they are still priced at a fair old margin to Base Rate -- typically at least 2% for best buy trackers, with many much higher.

Until last week that is, when one of the country’s biggest lenders, Cheltenham & Gloucester (C&G), launched a new mortgage that charges less than the current Bank of England Base Rate. And to first-time buyers with a small deposit!

So how does it work?

Below Base Rate

C&G's new low-start tracker charges 0.01% below Base Rate -- currently 0.49% -- until 31st December 2010.

This is mega cheap, effectively offering six months of payments (by the time you get a mortgage completed it’s likely to be late June) at an interest rate below the current record low Base Rate.

On a £150,000 repayment mortgage your monthly mortgage costs would be just £531.35 for the first six months, totaling £3,118.10. Brilliant.

It’s also got a standard mortgage fee of £994 -- not the cheapest around but not unusually expensive either.

But it is what happens next that you need to watch out for…

Rocketing rate

The deal is what’s known as a stepped tracker product and after the first six months the initial rate steps up a gear. Actually it steps up about five gears from Base Rate minus 0.01% to Base Rate plus 5.49% -- currently 5.99% until 31 July 2012.

So what starts out as a super low tracker rate becomes a pretty high tracker rate for the next 18 months. Your monthly repayments on a 150,000 mortgage would shoot up from £531.35 to £965.54 -- ouch!

So that means over the two-year deal you pay:

• £531.35 a month for six months (£3,188.10)
• Then £965.54 for 18 months (£17,379.72)
• Plus a £994 fee
• That totals £21,561.82.

By my calculations that’s roughly the same as paying around Base Rate plus 4.25% (pay rate 4.75%) for the whole two years of the tracker, including the same £994 fee, which actually isn’t the worst rate in the world at the top of this deal’s loan-to-value bracket of between 85% and 90% of the property’s value. But that’s only assuming Base Rate stays the same!

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And of course, it’s essential to be aware that things change radically if Base Rate goes up, when the C&G deal becomes much less attractive.

Massive exposure

It’s not hard to imagine the Bank of England Base Rate rising over the next few years. OK, so most economists (though not all) agree that it will stay at its current record low for at least the rest of this year, but after that it’s anyone’s guess.

The broad consensus of the so-called experts is that over the next few years Base Rate will begin to rise, which could start as early as Q1 2011.

If that happens your monthly repayments on the second stage of the C&G mortgage -- Base Rate plus 5.49% -- could rise much higher than you anticipated:

• A Base Rate rise of 0.5% would see them rise from £965.54 a month to £1,011.87
• A Base Rate rise of 1% would see them shoot to £1,059.21 a month
• And if the Base Rate went up to 2.5% before July 2012 -- still way below its long term average -- your pay rate would increase to 7.99% and your monthly repayments would rocket to £1,156.73. Gulp!

In other words, the second stage of this stepped deal is priced at a very high margin to Base Rate. It only works out an OK deal providing rates do not move upwards in the next two years, and that is a big if.

Tied in to a big risk

Once rates start to move the first-time buyers who take this deal are left horribly exposed to rising monthly repayments they may not be able to afford. Plus they are tied in for the two-year period -- with Early Repayment Charges of 4% of the mortgage up to August 2011 and 2% for the rest of the deal.

As one leading mortgage expert wrote in the press this week, this deal ‘exposes innocent first-time buyers to a level of payment shock that beggars belief’.

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In C&G’s defence, there are plenty of other tracker rates on the market at similar levels, that don’t come with the super low starting deal for six months -- and borrowers taking those are just as exposed.

Indeed, anyone on a variable rate mortgage, be it tracker or SVR, has the capacity to see their monthly repayments rise massively, and there is usually no limit as to how high they could go.

This particular deal has also been described as ‘innovative’ by some in the market. After all, it gives first-time buyers some breathing space during the most costly homebuying period -- those first few months when they are likely to be furnishing their new property.

But the fact remains that buyers need to go into this particular deal with their eyes wide open, as what looks so very tempting at first sight could be a very risky deal.

If in doubt, go to an independent mortgage broker -- like those available through lovemoney.com’s free mortgage service -- who can advise you on a deal that best suits your needs. Above all, they will ensure you that you fully understand any mortgage before you sign on the dotted line.

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First, adopt this goal: Cut the cost of your mortgage and pay it off early

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1st Time Buyers - Mortgages suitable for first time buyers with a maximum 15% deposit, sourced based on lowest payrate. Where a provider's logo is displayed products may be applied for directly.

Offset - Mortgages with an offset facility attached, sourced based on lowest payrate. Where a provider's logo is displayed products may be applied for directly.

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 4045 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 will revert to the lender's standard variable 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.