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One step beyond

Guy Anker looks at the controversy surrounding cheap introductory deals.

Abbey has introduced a stepped-rate mortgage that starts at 2.99 per cent but more than doubles after the first 12 months.

The offer comes shortly after the FSA sent out a warning to lenders about the dangers of creating a big payment shock for borrowers when a rate rises steeply after a cheap introductory offer.

In Abbey’s case, after a year of the five-year deal, the rate moves to 6.2 per cent for two years and then 6.35 per cent in years four and five, making an overall cost of 5.62 per cent.

Brokers say the deal could be useful for a borrower who needs the cushion of a year of reduced payments but warn that it compares poorly with other five-year rates.

Chase de Vere Mortgage Management director Nick Gardner says: “It is looking to attract first-time buyers and appeal to those that keep expenses tight at the beginning. It is not a bad way to do things but people should not be fooled by the early rate as the overall cost is more than many other five-year deals.”

Mortgageforce managing director Rob Clifford says: “Advisers have to be careful to ensure that consumers understand the implications and affordability of the product. Consumers should be careful about rates that start low and increase. There is a risk of consumer detriment as people do not always provide for the time when the rate goes up.

“But you have got to be careful not to regulate out a product, otherwise consumer choice would be radically restricted. Products that bridge the affordability gap should be welcomed.”

Gardner points to a 5.25 per cent five-year deal with Derbyshire Building Society as offering better value while Hamptons Mortgages technical director Jonathan Cornell likes Nationwide’s 5.34 per cent five-year deal.

Nationwide spokeswoman Tamsin Hemsley says the society is worried by deals that start so low. She says: “Our concern lies in the headline rate. In some circum-stances, we think it is a good idea for borrowers to keep monthly payments lower where people think their income will later increase but borrowers need to be aware of the total cost.”

The Abbey deal is aimed at first-time buyers, returners to the market and other borrowers who need a year of reduced payments, which can be beneficial if they need to buy furniture or other accessories for their home.

The firm defends the product by stating that it is completely transparent. Spokesman David Stewart says: “It is not fair to say this creates a payment shock as we are transparent that the rate will go up. People will be made aware from the start that it will inflate. There will be people out there looking for this type of mortgage.”

Last September, the FSA found that 41 per cent of borrowers choose a mortgage on price but focus on the initial payments rather than longer-term affordability. The regulator sent out a clear message to the market, stating: “There is a potential risk that consumers may get a payment shock when the discount period ends if they take out a very low rate but where there are no foreseeable changes in the customer’s circumstances that mean the payments are affordable.”

Moneyfacts data shows that other lenders which provide similar stepped-rate deals include Cheltenham & Gloucester and Portman Building Society. C&G’s loan works out at 5.19 per cent over five years when the first year’s rate of 1.99 per cent rate is factored in with the remaining 5.99 per cent. Abbey charges a £799 arrangement fee compared with C&G’s £999.

In January last year, Leeds Building Society introduced a 1.89 per cent deal that rocketed by almost 350 per cent after two years.

Moneyfacts is worried about the steep payment shock of such deals. It says: “Regulation has made it increasingly difficult for advisers and lenders to justify products which over the term of the deal could work out more expensive. People should not be lulled in by these low headline rates. Calculate the full cost of the deal and explore other options to achieve low initial payments.”

Its fears are echoed by John Charcol senior technical manager Ray Boulger who thinks lenders produce deals to tempt borrowers and then sell on other products such as insurance.

He says: “These are used to attract people and if they buy from that lender they can then sell other products. The steep step can be quite dangerous. I am surprised by this deal as the average rate on one of its other stepped rates is 5.51 per cent.”

Cornell says: “It is a huge payment shock as the mortgage rate will more than double in 12 months. For a five-year deal it is terrible value as you can get a much better rate over five years. I cannot see why anyone would want that type of deal as the value offered is poor.”

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