Hedge your future interest payments

Here is a recipe for disaster. You have a large fixed rate mortgage which is going to come to an end next year. And you have a very high loan-to-value (LTV).

When you come to the end of the fixed deal, not only do you risk an interest payment hike, but you may not be able to get a new fixed deal at all. The lenders may insist on a larger cash or value element than you have available.

The big danger is being stuck on a lender’s standard variable rate. It used to be the case that if the Bank of England cut its base rate, all the lenders cut their interest rates. But since the credit crunch, any interest rate cuts are not being passed on by lenders, because they urgently need to recapitalise their businesses. Halifax, Nationwide, Britannia, Skipton and Cheltenham & Gloucester have all raised their rates recently. So even if the Bank of England lowers interest rates, you can’t rely on the benefit being passed on to you.

What can you do to hedge or protect your position next year? One solution is to reserve a rate 6 months in advance. When you get a mortgage offer, the lender will often guarantee to lend to you at a particular interest rate and the offer can remain open for as long as 6 months. You have to pay a fee which might be 2½% of the loan, but balance that against the risk that if you leave it till 6 months time to renegotiate your mortgage, interest rates may have gone higher than ever making it impossible for you to afford the new mortgage rates. The beauty of this approach is that if offers you some protection if rates go up, but you don’t have to take it up. If everything changes in six months and there’s a better mortgage deal available at the time, you can take that instead. All you’ve lost is the fee. That may be a fair price to pay to secure yourself in an uncertain future.
It may be worth it if you are in negative equity, so you can’t sell or raise a mortgage elsewhere.

Some deals also come with a “drop lock” option which allows you to switch from a tracker deal to a fixed-rate deal without paying a penalty. The advantage of this  is that you can initially go on a tracker mortgage if you see interest rates dropping, but if they rise, you can switch to a fixed rate to avoid getting caught by a very high interest rate.