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The Anticipation of Interest Rate Rises Inflating Fixed Rate Mortgages

February 22, 2011

Fixed Rate Mortgages have increased in cost recently due to the markets (over) reaction to potential interest rate rises. The ‘swap rate’ (the cost of borrowing for mortgage lenders) has risen, which, in turn, has led to fixed rate mortgage deal costs being increased. The rise in the swap rate has been blamed on the fact that there is widespread expectation that the UK base interest rate will rise later in the year.

Although the Bank of England base rate has been frozen at 0.5 per cent, there is a widespread expectation that it will rise later in the year. This ‘expectation’ of future rate rises is increasing the cost of fixed rate mortgage deals, but possibly by more than they really should.

However, many feel that lenders have over-reacted, and that fixed rate mortgage deals may in fact come down later in the year, even if the base rate goes up a little. In other words, there seems to be a disengagement currently between the base rate, the swap rate – and fixed rate mortgage deals. This is even further exaggerated with high loan to value mortgage deals such as 90% mortgages, which lenders seem reluctant to offer now anyway and therefore price higher than equivalent lower loan to value fixed rate deals.

According to Ray Boulger from John Charcol, there are two key elements to the prices of home loans. He asserts that the short term cost of rates are determined by the Bank of England base rate, whilst the swap rate remains more significant for the long term fixed rate mortgage as it is based on whether interest rates are expected to rise or fall in the future.

The law few days has seen lenders making numerous changes to their mortgage rates. Aaron Strut from Trinity Financial Group argues “..banks now state on their websites that their mortgages can be withdrawn without notice and this will catch borrowers out”. He noted that recent changes included Santander withdrawing its two year fixed rate deal at 3.09 per cent and ING Direct pulling their fixed rate deal at 4.49 per cent.

Natwest have increased fixed rates by up to 0.4%. Their best fixed rate price at 50% loan to value is now 4.35 per cent compared with 3.75 per cent just a year ago, despite no change in the bank base rate over that period. Similarly, Coventry Building Society have increased some of their two year trackers by 0.38 per cent.

According to brokers, the more attractive existing fixed rate deals require a large deposit or people with significant equity in their homes. If prospective buyers can only offer a ten per cent deposit they will be required to have an impeccable credit history.

Although the rise in swap rate could mean difficult times ahead for homeowners and first time buyers, it could be better news for savers. If the cost of borrowing increases for lenders, they will need to attract cash meaning they may offer better rates on savers accounts. However, this benefit might not be as beneficial as it may seem if rising inflation exceeds the rate of saving.

22nd Feb 2011

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