Predicting the movement of interest rates over the coming years

Few economists can agree when the Bank of England will choose to raise the base rate, which is why homebuyers and homeowners weighing up whether to opt for a fixed-rate or tracker loan face the near-impossible task of predicting the movement of interest rates over the coming years.

Tracker rate mortgage schemes follow movement in the Bank of England base rate at an agreed differential. The tracker rate mortgage is available for a fixed period or the life time of the loan. The most common tracker rate period is 2 years, though many mortgage lenders now offer 3 year, 5 year and even 10 year track rate mortgages. If the tracker rate is for a set period of time the mortgage will revert to the lenders standard variable rate at the end of the tracker rate period.

With a fixed-rate mortgage the monthly repayment amount is fixed for a specified period irrespective of changes to the Bank of England’s base rate or the lenders standard variable rate. Fixed-rate mortgage schemes generally last 2 to 5 years, although longer terms are available. At the end of the fixed rate the interest rate reverts to the lenders standard variable rate. A fee called an early redemption penalty would apply if you chose to cancel your fixed rate mortgage within the fixed rate period.

Expert predictions for the path of interest rates vary widely. The latest poll by Reuters showed the consensus among economists was for base rate to be static until the final quarter of 2010, while the Centre for Economics and Business Research (CEBR), the consultancy, said rates were unlikely to top 2 per cent until 2015.

The investment bank Goldman Sachs, however, has one of the most aggressive forecasts — an increase to 1.5 per cent by mid-2010, 2.5 per cent by the end of the year and 3.5 per cent by the end of June 2011.

If inflation continues to rise, economists fear that the Bank of England will have to increase the cost of borrowing, making the option of a fixed-rate mortgage the best bet for borrowers. However, others economists caution that the UK’s public sector finances are in deeper trouble, leaving the Bank with little choice but to hold the cost of borrowing until at least the middle of next year, making tracker deals pegged to the base rate more attractive.

With this in mind, mortgage lenders have introduced new deals aimed at those borrowers who can’t make up their mind. HSBC is bidding to shake up the market with a new “split loan” mortgage. The deal allows borrowers to get the best of both worlds, pegging part of the loan to a variable-rate lifetime tracker and securing a fixed interest rate for two years on the rest.

The bigger the proportion of the loan that is fixed the more expensive the interest rate. Borrowers who have a 30 per cent deposit and want to fix a quarter of their loan and leave the remaining three quarters on a tracker will initially be charged 2.49 per cent on both parts of the deal. The tracker rate would be pegged at 1.99 percentage points above base.

However, if the same borrower opts to fix three quarters of the loan and peg the remaining quarter to a variable-rate tracker, they would be charged 2.99 per cent on both parts.

The deal is also available to borrowers who have at least a 20 per cent deposit, but with higher rates. At the end of two years the fixed rate reverts to HSBC’s standard variable rate, currently 3.94 per cent.

HSBC is not the first lender to allow borrowers to split their loans between a fixed and tracker rate. Lenders have been able to offer deals like this for some time, where part of the loan is taken on a fixed-rate and part on a variable tracker rate, with the exact percentage split according to the client’s circumstances.

The biggest high street lenders continue to use automated credit scoring to reject applications from borrowers with even the slightest blip in their credit history. However, the market is improving among niche lenders. A number of smaller lenders are stilling using staff to underwrite new mortgage applications. These lenders will still consult a borrower’s credit history, but they do not credit score applications and are increasingly willing to look at creditworthy borrowers who have one or two missed bill payments on their credit histories or a mark that could be explained.