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Drop lock out the charges

If I were a borrower seeking a nice low tracker but with an eye on base rate rises, a drop lock would be very appealing

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Jonathan Cornell

It was great to see that Woolwich has reinstated the drop-lock function on its tracker rates.

This feature allows borrowers to benefit from a nice low base rate to start with and then if rates rise, this allows them to switch over to a Woolwich fixed rate if they want to fix their payments.

But what is so special about that, as any lender allows you to change rate during a product term? The beauty of drop-lock products is that, unlike normal switching, the borrower would not have to pay an early repayment charge. With some ERCs at 3-4 per cent, switching product during the term is going to be very expensive.

You could probably argue that anyone in the slightest bit nervous about rate rises should steer clear of tracker rates and go straight for a fix right from the start but some borrowers want their cake and to eat it.

They look at the low base rate and the miserable predictions for the economy which indicate that the base rate is going to stay on hold until Harry Potter is drawing his pension and the temptation is too much.

What most people tend to forget, and you could point this out to the until they are blue in the face and they still will not take any notice, is that if the base rate goes up, then the fixed rates available will go up as well, so they will not be able to switch from their rising tracker rate to a sub-3.5 per cent fixed rate as they would all have been withdrawn and repriced upwards.

You could argue that if the base rate is going up, then the economy must be back on track and so the banks must be in a healthier state, so if this also means that funding has improved then it is possible that some degree of competition may have returned to the mortgage market.

With a bit of luck, this would force some degree of margin compression so the increase in fixed rates might not be quite so scary as we originally though. After the Bank of England’s gloomy growth prediction for 2011, the swap rate dropped significantly so current fixed rates may well drop.

Since drop-lock products have not been widely sold by lenders in the past, we have no real data on their usage in the past decade. However, even if they have not been used, they seem to be a valuable feature for prospective borrowers and this may influence them to take a slightly higher tracker rate which carries this feature compared with a cheaper one that does not.

Lenders sometimes forget that borrowers do not make all their decisions based on price. A few years back, Halifax removed the feature on its fixed rates that allowed borrowers to pay off up to 10 per cent without penalty as its research revealed that a minuscule percentage of its borrowers paid off 10 per cent per year so it was not something that was needed.

Halifax’s sales plummeted without this feature as, although not many borrowers used it, the vast majority planned or aspired to pay down some money every year. The feature was quickly reinstated it and its sales returned to normal.

With so few lenders offering drop locks, it may be Woolwich has this valuable feature for itself for the time being. If I were a borrower seeking a nice low tracker but with an eye on base rate rises, a drop lock would be very appealing.

Jonathan Cornell is director of communications at First Action Finance

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