With Bank of England interest rates holding at record lows, many Brits, especially pensioners looking to economise, are lining up to refinance their mortgages and take advantage of the lower monthly payments. Who can blame them? The numbers look good, and it is unlikely that such an opportunity will come along again anytime soon. What some fail to realise, however, is that if they aren’t careful, the short-term benefit they realise could end up being costly in the long run. Here are a few things to consider when weighing refinancing options for your mortgage.
Standard Variable Rate (SVR) Mortgages
The SVR mortgage is probably the preferred mortgage vehicle for most providers, as it allows them to set their own variable rate, and adjustments to the rate charged to the borrower can be wholly independent of the BOE prevailing interest rate. The banks usually charge low application fees and impose no early repayment penalties, to encourage borrowers to avail themselves of this type of mortgage.
No matter how attractive a package the provider might offer, the borrower should bear in mind that the bank’s ability to change at will the interest rate they charge could result in an increase in your monthly payments and the ultimate total cost of the mortgage.
Fixed Rate Mortgages
Unlike in the US, where mortgages are typically fixed rate for a period of 15 to 30 years, UK fixed rate mortgages are generally limited to terms of 2, 3, or 5 years. At the end of that period, the loan is converted to the provider’s standard variable rate. At the same time, the borrower has the option to refinance again, either with another fixed rate mortgage, on another terms agreement with the original provider, or by shopping around for a mortgage provider who offers better terms.
The potential problem is that it is virtually impossible to know what the prevailing variable rate will be at the time you are faced with converting or refinancing your loan. You need to crunch the numbers and at least estimate whether refinancing at the short-term, fixed rate mortgage will lower your monthly payments enough to offset the substantially higher processing fees inherent in a fixed rate loan. Bear in mind also that there are usually significant early repayment penalties applied which could eliminate any money saved via lower monthly payments, should you choose to pay off or refinance the loan before its term ends.
Tracker mortgage interest rates fluctuate with the Bank of England’s base rate, plus a predetermined add-on of roughly 1%. While a tracker mortgage’s interest rate – and your monthly payments – will fluctuate, you at least know that the fluctuation will be within a narrow range relative to prevailing interest rates. So long as BOE interest rates remain low, tracker mortgages can be a bargain.
Since the provider’s profit margin is constrained on a tracker mortgage, providers don’t impose high penalties for early payoff or refinancing by the borrower.
Discount Rate Mortgages
These mortgages are, as the name implies, structured much like a SVR mortgage, but at a discount from the provider’s standard variable interest rate. Terms of these mortgages typically run from 2-3 years, but longer loan terms can sometimes be negotiated. Application fees are low, but early repayment penalties do apply.
On all but the short term fixed rate or discount rate mortgages, the borrower is gambling on future interest rate fluctuations, which are, despite experts’ projections, largely unpredictable. In the case of the SVR mortgages, the provider’s historical exercise of discretion in setting their premium over and above BOR interest rates should be evaluated before entering into such a mortgage agreement. The ideal proposition would be to obtain successive fixed rate or discount rate mortgage loans as long as BOE interest rates remain low, but it is unlikely that providers will be particularly motivated to agree to such a pattern, since both types are ultimately less profitable to them. Tracker mortgages are often the most viable alternative for the borrower, as they offer a balance between the borrower’s total loan cost and profitability to the provider, and are the most likely to be acceptable to both.
In the event that you anticipate or are presently facing difficulty keeping up with your mortgage payments, it is advisable to consult with your provider before the problem reaches a critical level. If you find yourself at or near such a level already, the Consumer Credit Counseling Service (CCCS), now called StepChange Debt Charity, offers counseling and assistance in resolving problems before they begin to erode your credit record.