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Lock and load

A few years ago, when I was working for a newspaper, one of its senior executives came to see me about writing a story.

“We should look at the issue of mortgage lock-in penalties,” he told me. “They are an utter disgrace. Why should people who took out a loan have to pay these huge charges if they want to switch a mortgage?

“What I want you to do is a story on mortgages where the penalty does not extend beyond the period of the deal itself. Shouldn’t you be able to move whenever you want to – and not pay a redemption charge?”

It turned out that in late 1996, in common with many borrowers, this senior executive had taken out a five-year fixed-rate deal that the incoming Government’s inability to manage the economy would lead to interest rates, and therefore mortgage costs, rising sharply.

He and tens of thousands of others were locked into five-year deals charging up to 8.5 per cent and more over that period.

Unfortunately for them, when Gordon Brown became Chancellor a few months later, his first decision when in office was to hand over rate-setting responsibility to the Bank of England.

The result was that mortgage rates, far from rising, began to fall grad-ually in the late 1990s. Within two years, they were well below the level that borrowers had signed up for in late 1996.

For people like my boss, this was a disaster, hence his wish for me to write about the iniquity of lock-in deals of this kind. Nothing I could say would change his mind.

I was reminded of this discussion last week, after Brown announced that he wanted to see mortgage borrowers moving away from the typical two-year and three-year fixed rate deals commonly taken out today and seek out 25-year deals instead.

At first sight, it is not hard to see Brown wants to see a greater take-up of 25-year fixed mortgage deals. For borrowers, it means an end to the hassle of having to hunt around for a new home loan every two or three years, with all the associated legal, survey and application costs.

In addition, knowing exactly how much you have to pay every month for the next 25 years might also help reassure borrowers worried about everchanging interest rates.

The problem is that 25-year deals will always be sold alongside shortterm fixes, which are generally much cheaper.

Today, a quick trawl through any best-buy table will unearth various twoyear deals set at about 5.7 per cent. By contrast, most available 25-year fixed mortgages are about 6 per cent, perhaps a little more in some cases.

Nationwide last week joined the fray with a rate of 6.39 per cent and a fee of £599 for new borrowers. Existing borrowers will pay a higher rate of 6.49 per cent but a lower £499 fee.

Both deals come with a redemption penalty of 3 per cent in the first 10 years.

Of course, 25-year deals are usually more “stable”. Four years ago, you could pick one up for about 5.8 per cent. By contrast, two-year fixes were priced at 4.25 per cent. In effect, mortgage interest rates reflect what money markets believe is likely to be happening in the long term.

But equally, money markets are not all-knowing. The Sunday Times reported last week that in 1997, more or less at the time my boss was signing up to his five-year deal, you could also pick up a 25-year fixed mortgage from NatWest – priced at 9.49 per cent.

Can you imagine what it would be like for homebuyers to be locked permanently into that kind of deal today? According to calculations by the Sunday Times, a borrower with a £150,000 mortgage on that kind of deal would have paid £26,000 more in the past decade compared with someone who switched repeatedly to the cheapest two-year deals.

Breaking out of that deal would also be expensive. Even using Nationwide’s current redemption charges, which are relatively low, switching would cost £4,500 on that size loan.

In the past decade, one of the approaches of New Labour to the industry has been that of tinkering with product design, coming up with savings and mortgage products it believed were better for consumers than what is generally available.

Sometimes, its ideas have worked – or at least they have provided the catalyst for better and more transparent deals for consumers. In my view, that is the case with stakeholder pensions, whose opaque charging structures were a disgrace to the industry.

But stakeholder cash Isas and mortgages were a disaster. In almost all cases, competition has led to better products than those designed by the state. In my view, this drive to shove borrowers into 25-year deals carries the same potential danger for borrowers.

As for my senior executive, I did write the story, complete with quotes suggesting that people like him had been naive in signing up to expensive five-year fixed mortgages in the first place.

But at least in their case the decisions they took – however wrong – were their own. If the state were to intervene to skew the market, thereby costing borrowers thousands of pounds in extra mortgage payments, the blame would lie elsewhere.

Nic Cicutti is the editor of moneysupermarket.com. He can be contacted at nic.cicutti@money supermarket.com

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