Is Britain entering a prolonged period of ultra-low interest rates? According to a major report this week, interest rates will stay at rock bottom for years as the government tackles the UK's wounded economy. If so, it's likely to reshape our whole approach to personal finances – and make choosing the right mortgage more important than ever.
The stakes are high. Householders who opt for the current best five-year fixed rate will pay about £580 a month for each £100,000 of borrowing. Those who choose the best tracker deal will pay £460 – or as little as £230 a month if they go for the interest-only option.
If rates don't move up – and that's a big if – then the person with the typical-sized mortgage (£120,000) who opts for the tracker will, over five years, save around £8,600, in comparison with the mug who took the pricey fixed rate.
But are those choosing fixed mortgages really such mugs? No one forecast that the base rate would fall to 0.5%. No one can be sure it won't bounce back to well above what we became used to before the credit crunch. As recently as 1998, the average mortgage rate at Halifax was 8.95%. If the Bank of England's "quantitative easing" turns into inflation, then interest rates may have to move up sharply – and anyone on a long-term fixed rate will be laughing.
More likely, someone taking a tracker will enjoy a low monthly starting rate but face gradual hikes, with the consensus view among economists that rates will begin marching up (albeit slowly) from the middle of next year. Given that scenario, will it still make sense to take a tracker loan? Guardian Money asked HSBC – which currently has the cheapest five-year fix (4.95%), and jostles with Woolwich for the cheapest lifetime tracker loan (base rate plus 2.24%, giving a current pay rate of 2.74%) – to do the sums.
Steady rate rises: No rise in rates for nine months, then a 0.25% increase every three months until month 60. By month 60, base rate would be 4.75%, and the tracker rate payable would be 6.99%. But the tracker holder will still win, paying £33,559 over the period on a £100,000 loan, compared with £34,900 on the five-year fix.
Faster rate rises: No increase in rates for nine months, then a 0.25% increase in the base rate every two months until month 60. By month 60, base rate would be 7% and the tracker rate payable would be 9.24%. The person who opted for the tracker will lose out, paying £36,649 over the period for each £100,000 of borrowing, compared with £34,900 on the fix.
For some borrowers, particularly at Nationwide and C&G, there is another option, and one that looks for most like a no-brainer right now. Both lenders have highly attractive "revert to" rates that anyone coming off a deal can switch to. The standard variable rate (SVR) at the two lenders is just 2.5%. What's more, you don't have to pay any arrangement fees – which are £999 for the HSBC deals named here. You can also sit on the SVR sidelines and then jump into a better deal if and when it becomes available. In the past, falling on to the SVR was the worst thing a borrower could do, but today it's about the best thing. Sadly, these deals are only available to existing customers, not new ones.
Ray Boulger, technical director, John Charcol: Go for a tracker If you look at recessions caused by banking crises, the recovery always takes longer. If there is a restriction on the amount of credit, then it's likely we'll have low inflation and interest rates for quite some time.
Between February and June we were recommending five-year fixes, but since then trackers have become more popular – 58% of our clients are taking them. Fixed rates now look expensive. If you could get a long-term fix of 3%-4%, then great: but you can't. The best is HSBC's 4.95% over five years. All the others are more than 5%.
It's important to look at the "revert to" rate on your loan: it may be very good. Also if you have a high LTV (loan to value) – say above 80% – then you are not going to find any attractive fixed or tracker remortgage deals, and should perhaps move on to the standard variable rate (SVR).
Lifetime tracker deals offer the best value now – Woolwich has a deal at base rate plus 2.29%, with up to 70% LTV, while HSBC has a slightly cheaper base rate plus 2.24%, but with a maximum LTV of 60%. We're finding lifetime trackers just as cheap, if not cheaper, than short-term trackers, and the penalties for getting out are usually no more than 1% for the first two years.
Robert Barrie, head of European economics, Credit Suisse: Rates aren't heading above 2% We think the economy can and should enjoy a strong recovery. Not only that, we don't think it needs to slow down anytime soon. The only good thing that comes out of a recession is the spare capacity that allows a strong recovery, without inflation being an issue for some time. Having said that, it's taking things a bit too far to suggest rates can stay quite as low as they are for a lot longer. I know the Federal Reserve says something like that about US rates but the point is that levels matter more than changes.
Even if rates start rising – as we think they will – around the middle of next year, they are likely to be very low for some time. They might get to 2% by the end of next year – a bit higher than now, but not high in any other sense.
Philip Shaw, chief economist, Investec Securities: Rates will hit 2.5% next year The economy seems to be recovering; inflation, though low, has not fallen as much as expected. Meanwhile the pound has fallen sharply since the summer. Bearing these in mind, we are sceptical that official interest rates will remain close to zero indefinitely, and our view is that rates will rise next year, possibly early on. We recognise public expenditure is likely to be cut, perhaps significantly, and that banks are not in a position to extend credit freely.
This will probably limit the speed of the upturn and result in interest rates remaining low for an extended period. We expect the base rate to rise to around 2.5% by the end of next year, and stay there through most of 2011.
It is very difficult to give a general recommendation on fixed, against floating, rates and greater competition in the mortgage market appears to be resulting in more attractive deals.
But as a guide, our call on an early rate rise suggests two-year fixed rates have the edge on tracker products. We would avoid longer-term, fixed-rate mortgages, which look very expensive.
Larry Elliott, economics editor, the Guardian: Track, but for three years only On the face of it, there has never been a better time for a fixed-rate mortgage. The base rate is 0.5%, the lowest since the Bank of England was founded in 1694, and clearly will not be at this emergency level for ever. But policy may remain looser for longer than the markets expect. Private-sector spending in the economy remains weak and, until there is evidence of real recovery in consumer spending and investment, the Bank will remain wary of raising rates. It will start the tightening process by withdrawing the stimulus from quantitative easing – dearer borrowing costs will come later.
Also, the aggressive action promised by all political parties to cut the government's budget deficit through higher taxes and public spending restraint means there will be far less pressure to raise rates.
The response to the financial crisis makes it harder than ever to predict what will happen to interest rates, and the further ahead you look the more difficult it gets. On balance, I would favour a tracker mortgage over a fix, but for no more than three years.
Doug McWilliams, chief exec, Centre for Economic and Business Research: Expect 0.5% rates until 2011 at least The next government will need to generate £100bn in tax rises and spending cuts to get the budget deficit down to £50bn by 2014/15. We are likely to see an exciting mix, with the fiscal policy lever pulled right back and the monetary lever thrust into fast forward. This means low rates, more quantitative easing and probably low bond yields, and a fairly weak pound. Low levels of growth in wage settlements should keep inflation low enough to prevent the Bank from having to raise rates until the economy is fully in recovery mode.
The risk to this scenario playing out is that oil, primary commodities or food prices start to rise more quickly than we expect. However, we think the Bank will just about get away with it, so we predict a base rate of 0.5% until 2011 at least.
Theo Zemek, global head of fixed income, Axa: Inflation may be coming back Inflation does not seem to be a problem. The authorities are more concerned about the economy weakening. That said, it would be a mistake to assume the inflationary problem is dead. The measures taken to combat the crisis – massive issuance of government bonds, the injection of huge quantities of liquidity into the system and the retention of (arguably) artificially low interest rates – may spark inflation pressure further down the line.
The risks are probably greatest in the UK and US where there must be temptation among politicians, and central bankers, to inflate their way out of the debt mountain. So I fear that some inflation creep is inevitable, perhaps a year to two years out. It doesn't take much inflation to erode the yields on offer in these markets.
Figuring it out
Should you bail out of that pricey fixed-rate mortgage you signed up for a while ago in order to take out a cheaper tracker deal, in the belief that interest rates will stay low?
You need to look carefully at your early repayment penalty, and factor in such costs as arrangement/valuation/legal fees etc. You will also have to pass new, tighter credit checks.
A lot will depend on how long your deal has left to run. It is usually more likely to be worth switching if you have a few years left rather than a few months. Things also get complicated if your property's value has fallen since you took out the loan. The best new deals tend to be reserved for those who want the lowest loans as a percentage of their home's value.
Mortgage calculators on sites such as John Charcol can show how your mortgage stacks up against other deals. The Guardian's website features a mortgage switching calcualtor aimed at people stuck on fixes that no longer look competitive.
Let's take the example of people with a £150,000 mortgage who took out a three-year fix at 6.35% in July 2008. If they are interest-only and currently paying £793 a month, this would fall to £348 if they signed up for a tracker priced at 2.79%. They would save £8,900 in monthly payments by bailing out now and taking that deal rather than waiting to the end of the fix. But let's say they have to pay a 2% early repayment charge – that reduces the saving to £5,900. Then knock off the £999 product fee for taking the new deal. That's still a respectable £4,900 saving.
But (a big but) these calculations assume interest rates stay where they are. If they start to go back up, this will eat into those savings
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