In the aftermath of last week’s turmoil in financial markets, interest rates on fixed rate mortgages are likely to rise. But don’t panic and rush into a deal – this is almost certainly a blip in the interest rate downtrend.
Several newspapers and websites have urged borrowers to hurry to close a mortgage deal. I think they’re over-reacting and that interest rates will soon resume their downward trend.
The Bank of England’s base rate remains unchanged at 5%, and almost to a man economists expect it to fall soon. Predictions for where it will get to next year vary, but the most conservative predictions I’ve seen are 4% by the end of 2009 while others say it could fall as low as 3% next year. The latest bout of panic in the markets makes it more likely that the Bank will make a quarter-percent cut by January.
LIBOR is key
But most mortgages aren’t priced off base rate. Lenders use LIBOR – London Inter Bank Offered Rate – because this is the rate they pay to raise money in the wholesale money markets. 3-month LIBOR is 6.01% this week, up from 5.74% at the start of the month.
So lenders, who had cut mortgage rates in August as LIBOR dropped, may now be under pressure to raise variable mortgage rates again.
At the same time, 2-year swap rates - the market rates used to price fixed-rate loans - edged up 0.3% to 5.73%. Only two weeks ago, many lenders cut 2-year rates and for LTVs of 70% or below, you can still get a 2-year rate lower than that.
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US acts to stem crisis
These rates have risen simply because of fear and uncertainty. Yet the Federal Reserve and the US government are acting with astonishing rapidity and force compared with previous crises. It took ten years of a slow meltdown in Japan before a ‘bad bank’ was established to clean up the sector.
Ironically, it’s because the Japanese banks only finally returned to health three years ago that they’ve avoided all the subprime horrors and toxic derivatives that have blown up the US banks and hedge funds. One of them, Mitsubishi, was able to pick up a shareholding in Morgan Stanley at a knock-down price this week while another, Nomura, is buying up Lehman’s Asian operations for a song.
So the US authorities’ response to the crisis has been as much as anyone could expect and again shows why America remains such a powerful force in the world. They have forced through bank takeovers, nationalised their largest mortgage lenders (Fannie Mae and Freddie Mac) and insurance company (AIG), and supported banks with vast short-term loans.
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Europe not the US
There isn’t the remotest chance the Europeans could act in concert on a sufficient scale in a financial crisis, so we had better hope that Uncle Sam can do the job. Getting the proposed $700 billion bailout fund through Congress is tricky and uncertainties over how it will work will continue, but now that there is a government-backed backstop the chance of a financial meltdown is minimal.
And it’s also worth remembering that this is a US crisis. It’s US banks and insurers that are failing, and while we can expect some knock-on failures in Europe and elsewhere, these will probably be small-scale compared with the bloodbath on Wall Street.
That means the current bout of market nerves is likely to subside in coming weeks, with both LIBOR and 2-year swap rates resuming a gentle downtrend. 2-year swaps peaked at 6.4% six months ago and before the latest blip had almost got back down to the level they were at a year ago. I’ll be surprised if both aren’t significantly lower by Christmas. The only weak player left in the UK banking market is Bradford & Bingley and I expect it to get taken over soon. But it’s so small this won’t affect the market much.
So this is not the time to panic and rush into a fixed rate, especially if lenders do start to raise mortgage rates. But they may not. As I said two weeks ago, what the two rounds of interest rate cuts in August proved was that the UK market for mortgages is again competitive. Because so few new mortgages are being taken out, lenders are chasing the remortgage business, and especially higher-quality borrowers. Loans at under 70% LTV are good value.
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Go for a tracker
So if you are coming to the end of the term on a current mortgage deal, your best option is, in my view, a tracker mortgage. Because this tracks Bank of England base rate, you aren’t exposed to the shenanigans in the money markets. And almost certainly you’ll see your repayments fall next year. Current rates are around 5.7%. Several lenders now offer trackers with the option to switch free of charge to a fixed rate, and this is certainly an option worth having.
If you’d prefer a fixed rate, then you can try to reserve a rate now – most lenders will reserve a loan for up to three months, so if your lender still has a good fixed rate on the shelf you could take advantage of that. But while you won’t have to pay the arrangement fee if you decide not to go ahead, you will have to pay a booking fee, which is usually non-refundable.
My own view is that fixed rates will probably be lower in January than today, so you may not gain any advantage from reserving. As for HBOS, Halifax borrowers can expect no change at all in the bank’s policies on lending in the short term. It will take months for the Lloyds TSB takeover to go through and it will probably be the end of 2009 before we see any significant changes in products or lending policies at the combined group.
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