Q: If someone is choosing between a two-year fixed deal and a five-year fixed deal, working on 80% LTV or below, do you think the big difference between the two types of rates will pay off over five years – taking into account that after two years on the lower rate the client would possibly remortgage and have to pay a booking fee (and maybe after four years as well)?
Answer from Ben Thompson, director of mortgages at Legal & General
A: David, great question, thank you. There are ‘knowns’ and ‘unknowns’ to be dealt with to answer this question.
If I can take the unknowns first:
Bank Base Rate (BBR) as you know is both at a historical low and has probably been as benign as BBR has ever been over the last 18 months or so. This of course is exceptional to say the least and quite simply because we are still handling an emergency in the economy, albeit one hopes less so than a couple of years ago.
The point here, is what will happen to BBR and the cost of borrowing in the next five years? Although rhetorical, the question needs to be answered before a decision can be made. It may feel cheaper now to take the two-year fix and switch in two years’ time for another fix; this wouldn’t be the case should the cost of fixing have risen during that timeframe.
Where is the cost of borrowing headed? According to Legal & General Investment Management (LGIM): “With growth lacklustre, the Bank of England (BoE) will need to provide offsetting support to the economy. As a result we do not see official rates moving from 0.5% through the course of 2011 while the average forecaster (or ‘consensus’) is anticipating official interest rates to rise to 1.25% by the end of 2011.”
So, as always, there is a mix of views, however I will stay with the house view and assume no shift for at least 15 months.
With that said, swap rates typically move in advance of BBR and that would mean the cost of fixing is probably rock bottom now and will only rise from here. On that basis, a strong argument should be made to look at the five-year option as the cost of the second fixed rate would only have to rise by a small percentage (approximately 1.25%) to make it more expensive overall.
Fixing for five years, if suitable for client circumstances especially if they are well geared, has to be the safest and most prudent option, given that fixes are low now and at some stage will increase.
If one assumes a totally flat outlook, then we can deal with the ‘knowns’:
80% LTV / £130,000 mortgage / assumes fees of less than £1000 / interest only
Lender A – 4.19% for two years reverting to 3.99% for the next three years. Cost = £26,454
Lender B – 4.99% for five years, Cost = £32,434
Under a flat/benign scenario, the two-year fix/re-fix would look better.
Summary
If a customer is highly geared and/or believes BBR and the cost of borrowing will start to rise in two years’ time, they should fix for five years.
If the customer believes, like some forecasters, that we will remain in troubled times with flat BBR and historically low cost of borrowing for many years, take the two-year option and rethink at that time.
What would I do (for what it’s worth)?
I would fix for five years.
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