Beware the lure of the new, cheap, two-year fixed deals

First-time buyers should think long-term when choosing a loan. A higher rate could actually save you money

First-time buyers enticed by super-cheap mortgages should think twice before opting for record-low rates.

The number of two-year fixed-rate deals for those with a 10 per cent deposit is at a high and the rates are at a low. However, buyers who choose these deals could end up paying hundreds of pounds more than those with five-year fixed deals if interest rates start to rise next month.

According to Moneyfacts, the consumer analyst, there are 275 deals at 90 per cent loan-to-value (LTV), with an average rate of 2.63 per cent. Five years ago there were 101 deals at 90 per cent LTV, with an average rate of 5.47 per cent.

With a possible rate rise as early as November, opting for a two-year fix now may be unwise. In anticipation of this, swap rates — which reflect market expectations for interest rates and determine the cost of borrowing for lenders and, in turn, borrowers — are already moving upwards.

Brian Murphy, the head of lending for Mortgage Advice Bureau, a broker, says: “It’s easy to see the appeal of some of the ultra-low two-year deals, particularly those below 1 per cent. However, first-time buyers would be wise to think more holistically. Cheapest isn’t always best. There is a certain apathy towards the fact that interest rates are likely to rise at some point, and therefore the desire for long-term security isn’t as far up their agenda as it has been for other generations.”

Ray Boulger, a spokesman for John Charcol, a mortgage broker, says that not only will interest rates increase mortgage costs when you remortgage, but the fees required to switch deals usually amount to thousands of pounds. He estimates that someone with a £225,000 30-year mortgage would save more than £300 within five years by opting for the cheapest five-year fix at 2.39 per cent with Digital Mortgages, compared with the cheapest two-year fix of 1.85 per cent with the same company.

This assumes that the borrower on the two-year rate remortgaged twice, paying a £900 fee each time, and that their rate went up 0.4 per cent each time. He says: “There is also the risk that, due to a change in personal circumstances, it would not be possible to remortgage, or at least not on prime rates. Even a small increase in the cost of remortgaging would wipe out any saving made by an initially cheaper deal.”

It is in lenders’ interests to offer more two-year fixes, according to Adrian Anderson, the director of Anderson Harris, a mortgage broker. “Long-term fixed-rate mortgages are better value than short-term deals,” he says. “With appetite among borrowers strong for five-year fixes, there is less need for lenders to provide further long-term options. So, there is a tendency to offer attractive short-term fixes in order to balance the overall lending book.”

There are some circumstances where opting for the short-term deal may be the sensible choice. If you can pay off enough of the mortgage to qualify for an 85 per cent LTV deal when you switch, the costs will be much cheaper, so it may be worthwhile.

A long-term mortgage is also a risk if there is a chance you may want to move or that you or your partner may want to sell. Early repayment charges range from 1 per cent to 5 per cent, so the cost of paying off your £225,000 mortgage early could be £11,250.

The number of two-year fixed-rate 90 per cent LTV deals available has increased 29 per cent in the past year.

Charlotte Nelson, a finance expert at Moneyfacts, says: “Many borrowers who took out a 95 per cent LTV deal a few years ago could be starting to weigh up their options for remortgaging into this section of the market. Providers who don’t want to lose a chunk of their mortgage book have to up their game by not only offering better choice, but also lower rates.”