Applying for a mortgage under the new affordability criteria is arguably the financial equivalent of a visit to a doctor with an embarrassing complaint. You’ll almost certainly find yourself being instructed to disclose details of your lifestyle that you may prefer to keep private. Even though you can trust the confidentiality of the people concerned, it’s still an intrusive process, albeit one which will hopefully have a happy outcome.
While industry pundits debate the pros and cons of the long-term impact on the housing market, prospective buyers are far more interested in the practical realities of financing a house purchase. As is so often the case when restrictive rules are introduced, people may look to see if they can find a way around them. Mortgages with fixed-rate terms of five years or more are exempt from the new rules. The logic behind this is that, by definition, buyers on fixed-rate mortgages know exactly how much they need to repay each month and therefore are cushioned from the spikes in interest rates which were such a painful feature of the 1970s and 1980s.
It is important to understand that these fixed-rate deals are not necessarily going to work out cheaper overall than a variable-rate deal or even a deal with a shorter fixed term. First of all they tend to charger higher arrangement fees. Secondly lenders may only offer fixed-term rates which give them a good chance of making a profit overall. Since nobody knows for sure exactly what interest rates are going to do in the future, lenders base their offers on educated guesses and currently are likely to err on the side of safety. This means that depending on what actually happens to future interest rates, a fixed-rate mortgage may actually work out more expensive than a variable-rate mortgage. It’s also worth remembering that fixed-rate deals tend to carry early-exit penalties. In theory, these will still apply even if interest rates go on a downward trend (which is admittedly unlikely for the immediate future given that they are already at historic lows). In practice the regulator may take an interest if lenders look like they are profiteering at the expense of people who want to exit mortgages which are at much higher rates than those prevailing in the market. Potential buyers should, however, work on the basis that if they want to end their mortgage during the lock-in period they will have to pay to do so.
On the other hand, fixed-rate deals provide a degree of security and can make it vastly easier to manage the family finances. It’s also fair to say that as products increase in popularity, lenders often find themselves forced to innovate to differentiate themselves to attract customers. This is generally good news for the consumer.
There are signs that this is already starting to happen in the UK market. In fact there is a strong case for arguing that the growth in five-year deals is a significant innovation in itself; given that two to three year fixed rates have been the de facto standard in the UK for many years. Some lenders are going even further and offering fixed rates for as long as 10 years. These were previously unheard of in the UK since their lack of flexibility made them unpopular with borrowers and lenders alike. One lender, however, has thrown down a gauntlet with the launch of a product which offers a 10-year fixed rate but only charges early exit penalties for the first five years. If this proves popular, then it’s a reasonable assumption that other lenders will step into the ring