End of the cheap fixed mortgage

Britain’s banks stand to reap a £900m windfall from the recovery as mortgages look set to rise for the first time in a year.

Brokers have warned that the average five-year fix could hit 6% within weeks, up from 5.6% at the start of last week and as little as 3.95% three months ago. Deals as low as 4.5% are still available but they are expected to disappear fast.

Lenders are blaming a sharp rise in the cost of funding mortgages in the money markets, where rates have risen as the City becomes more optimistic about a recovery.

However, research for The Sunday Times by Capital Economics, based on Bank of England data, has found the rises are as much to do with bank profits.

The average five-year fix of 4.92% in May was 1.84 percentage points above the cost of funding. A year ago, when the average five-year deal was 6.11%, the margin was just 0.87 — so lenders are pocketing an extra 0.97 points. They have boosted margins on two-year fixes by a similar amount over the past year.

With fixed-rate mortgages accounting for 69% of the £7.25 billion of loans made last month, according to the Council of Mortgage Lenders, the rise in margins nets banks an extra £72.5m a month or around £870m a year.

Seema Shah of Capital Economics said: “Lenders are pricing a bigger margin today than at the peak of the credit crunch last September. This is boosting profits but it’s also a way of rationing credit. Over the past decade we’ve seen tiny margins or loss-making loans. What we have now is more similar to what we saw in the early 1990s.”

The rapid change in the outlook for rates came as the National Institute of Economic and Social Research declared last week that the recession probably ended in March, with economic growth rising slightly in April and May.

Economists cautioned against a return to boom conditions but the move nevertheless pushed up sterling against a basket of currencies.

Yet while mortgage rates are going up, savings rates are falling, as banks target other ways to boost their margins.

On Friday, Marks & Spencer became the latest institution to cut its Isa rates. Its Advantage Cash Isa was reduced by 0.60% points to 2.50%.

We look at what prospects for economic recovery mean for your finances.

Mortgages

Brokers are urging borrowers to take out fixed-rate deals for a minimum term of five years to guard against interest-rate rises.

While Bank rate is not expected to go up until next year, the cost of funding mortgages has already moved in anticipation.

Last week, Nationwide, Britain’s biggest building society, raised its five-year fix for borrowers with a 40% deposit by 0.86 points to 5.84%. Northern Rock also raised five-year deals by 0.2 points last week.

Ray Boulger of John Charcol, the broker, said: “There is no question lenders are going to pass on these rates. The message for borrowers wanting to take a fixed rate is clear — get in now or miss out on the current relatively low rates.” Chelsea had a five-year deal at 4.5% last week but this was pulled on Friday.

The next-best deal, from Mansfield building society, is at 4.59% for those with a 25% deposit, with a fee of £999 — although it is unlikely to last the week.

Repayments on a £200,000 loan would be £765 a month with the Mansfield deal, but would rise to £1,000 if the typical fix hit 6% — an extra £2,820 a year, so it is worth acting fast.

Melanie Bien of Savills Private Finance, another broker, said: “We would not be surprised to see a 0.5 point rise across the board. An average five-year fix at 6% is much closer to the historical average.”

The best two-year deal is from HSBC at 2.49% but the fee is as high as £3,800 on a £200,000 loan with a deposit of 25%.

Savings

Despite the prospect of rate rises, interest rates are so low on new variable accounts that you are likely to be better off taking out a short-term fixed-rate bond.

The best variable rate account is from Intelligent Finance’s internet account at 2.85% on a minimum deposit of £1, after it raised rates by 1.1 points last week. However, the top-paying one-year bond from National Counties building society pays 3.91%, so rates would have to rise by more than 1.06 percentage points before you would be better off.

Currency

Last week, sterling hit its highest level against the euro for the year, reaching ¤1.17 after the near-parity levels of ¤1.02 in December. However, prospects for sterling against the dollar are more limited.

John Higgins of Capital Economics said: “The general improvement in risk appetite is reducing the safe-haven appeal of the dollar. However, as we move through the summer, the strength of the recovery will be disappointing, risk appetite will fade and the dollar will gain a little more strength against the pound.”

Investments

The sharp rise in the outlook for rates is bad news for investors who have piled into corporate-bond funds, as their yield looks less attractive relative to other assets so prices fall and yields rise.