How to deal with rising mortgage costs

Around 2.8m homeowners are set to feel the pinch when the cheap mortgage deal they struck two years ago comes to an end. The Council of Mortgage Lenders estimates that around 1.3m borrowers took out fixed-rate mortgages in 2005, and a further 1.5m in 2006.

Many of these deals were taken for two years, meaning a large proportion will expire over the next 18 months. Since then there have been four interest rate rises, and with the Bank of England expected to increase the base rate to 5.75% at its July Monetary Policy Commitee meeting, homeowners could face a hefty increase to their mortgage costs when they remortgage.

Two years ago, the most competitive fixed-rate mortgage deals were around 4.5%. Todays offers are at 5.5% and may increase further if interest rates rise again. On those terms, a borrower with a £300,000 repayment mortgage over 25 years would see monthly payments jump 10% or £174 from £1,668 to £1,842. But while all borrowers coming off cheap two-year fixes will face a payment hike, there are options to help ease the pain.

Shop around early for a new mortgage deal

Borrowers coming to the end of a fixed term should shop around for a new deal as soon possible. You need to ensure another deal is in place so that you can simply make a phone call and trigger it on the day your fixed rate expires. Borrowers should plan ahead by diverting funds into a savings account so they can pay off a chunk of mortgage and get used to paying higher mortgage costs.

Anyone shopping around for a new deal will also face the dilemma of whether to choose a fixed rate or opt for a tracker. If you want the financial security of knowing what your monthly outgoings will be, then choose a fixed rate. But the price of fixes is rising as two further 0.25% base rate rises have been priced into many products.

While many expect the base rate to hit 6% this year, a tracker may work out better, particularly if base rate comes back down again next year. Borrowers changing lenders who have equity in their homes could borrow a little more than they need, say an extra 5%, and immediately over-pay the mortgage, this may give them the option of a payment holiday in the future.

Switching to interest only could be another short-term solution. It will cut your monthly payment but if you never pay off the loan, it will cost you more over the life of the mortgage because you continue to pay interest on the whole amount throughout the term. And this debt will need to be addressed sometime. That will either mean even higher repayments or extending the term of your mortgage and paying yet more interest.

02 July 2007 © Moneyextra.com

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