To fix or not to fix, that is the question

by Andy Golding, Chief Executive of Saffron Building Society

The question that every borrower wants to know the answer to is whether to tie themselves into a fixed rate mortgage deal, and at least get certainty, or whether to take a gamble on a variable rate and hope it pays off.

The answer is all a matter of what happens to interest rates. In the strangest set of economic circumstances for at least 60 years, there are many opinions but very few facts to go on.

Economists use the phrase “balance of probability” quite a bit, so what is the balance of probability for the direction of UK base rates?

Interest rates are used by the MPC to control inflation. The basic theory being that rising rates take capacity out of the economy and falling rates put it back in. With rates at an all time low and having been so for quite some time now, plus the impact of the significant Quantitative Easing programme, both designed to stimulate the economy out of recession, you could expect that now that the UK is back into growth again, that inflation could start to rise quite rapidly.

The latest readings show that high street sales picked up more than expected and the Bank of England’s survey of regional agents showed some relaxation in the availability of credit, some signs of rising pay and continued growth in the manufacturing sector.

The target CPI measure of inflation hit an eighteen year high of 3.7% in April, though has since dropped slightly to 3.4%, is still comfortably above the target rate of 2%. The RPI measure shows the cost of living having increased by more than 5% over the last year. The rise has been largely driven by the reversal of the VAT reduction, the weakness of sterling and higher fuel costs.

However, the Bank remains confident that the CPI measure will drop back below 2% within a year, as was outlined by the Governor in his letter to the Chancellor following the inflation release. The decision to keep monetary policy on hold has been unanimous until June’s MPC meeting, where one committee member voted to raise base rate to 0.75%. The MPC are also highlighting the need to tackle the fiscal deficit, although the Governor welcomed the plans he had seen last week. A credible deficit reduction strategy would increase the likelihood of rates remaining lower for longer.

The risks to the Bank’s view are that energy prices continue to rise as they have been doing, spurred on by speculators and Chinese consumption, (whose economy has returned to double digit growth) and VAT increases introduced in the emergency budget, coupled with strong exports and a continuing relaxing of credit. These factors together would push inflation higher still and would therefore put pressure on the Bank to raise rates.

So do you fix or not? Rates could rise quicker that the Bank are currently predicting. Probably not much, if at all in 2010, but potentially in 2011.

As a mortgage borrower, fixing now for, say, 5 years provides certainty of price. Fixed rates are unlikely to get any cheaper.

That said even best buy fixed rate mortgages are significantly more expensive than best buy tracker or variable rates. If Mervyn King is right, you will take a hit on additional cost unnecessarily. Either way it’s a gamble. But even at 50/50 odds, ask yourself whether you could afford your mortgage if rates went up 3.5%. On a £150,000 interest only loan that is an increase of £437.50 per month!

There is no right answer, which is why Saffron offer both fixed and tracker mortgages in order that borrowers can choose whichever mortgage they feel most comfortable with. The advice we give is always to consider what you could afford if your payments increased, and whether that increase would be unfortunate or unfeasible for your circumstances.

Saffron Building Society is a regional building society and has been providing savings accounts and mortgages to communities in the East of England for over 160 years. They offer a range of fixed rate mortgages and tracker mortgages. They have over 120,000 members and are the ‘most followed’ Building Society on Twitter! Visit us at www.saffronbs.co.uk or follow us @SaffronBS