Are pre-booked mortgages good rate rise shields?

Some lenders allow plenty of time after application to draw cash meaning those on cheap variable deals can enjoy them for longer before moving to a fix, while those whose introductory offer will expire in a few months can secure their next deal now (see The Remortgage Guide).

The Confederation of British Industry (CBI) predicted this week high inflation will force the Bank of England to raise interest rates gradually in the spring from its 0.5% historic low.

The CBI forecasts the base rate will hit 2.75% by the final quarter of 2012. If correct, this would add hundreds of pounds a year to typical repayments on a variable mortgage.

This has led some experts to suggest borrowers should consider fixing mortgage costs soon as home loan rates tend to rise before base rate does.

How pre-booked mortgages work

Reserving now acts as an insurance policy against rising costs for those who want to switch.

Millions of borrowers are sitting on their lender's standard variable rate, which most deals revert to after an introductory period. These were expensive historically but the rock-bottom base rate means some are cheap – as low as 2.5% in some cases.

If rates jump and you move to a pre-booked fix you've not lost out. But if you dump the fix because you want to continue on a variable rate or you find a better fix you will lose any fee – that can hit £200 – payable on application.

'Fee-free' deals sometimes come with withdrawal charges for those who don't take the mortgage after being approved.

Many lenders used to offer six month deadlines to take the cash as standard but these have been cut back to a typical three months, according to brokers. Yet some six-month, or longer, terms still exist.

David Hollingworth, from broker London and Country, picks out a two-year fix from Woolwich at 3.28% with no fee as a decent option for wannabe fixers who are borrowing no more than 70% of the value of their home.

Here, you don't need to take the money until 31 July, though there is a £150 withdrawal fee.

Coventry Building Society, Hollingworth adds, offers a five-year fix at 4.35% for those borrowing no more than 75% of their home's value that gives you six months to take the money.

It comes with a non-refundable £199 booking fee (which you will lose if you decline the mortgage) plus an £800 charge you pay when you complete (that you won't risk losing).

Pre-booked mortgage warning

Brokers warn deals with reservation limits over three months are not always the best but they are worth considering.

Hollingworth says: "Borrowers should first decide whether they want to fix. If they do, reserving is an option as it may give borrowers longevity on a low variable rate.

"But it is important to look at the whole market not just the deals with long draw down deadlines as you may find a lower rate."

Should you fix?

CBI chief economic adviser Ian McCafferty says: "Households will most likely face higher mortgage interest rates next year."

The Bank of England estimates over seven million borrowers are sitting on variable rates which will jump in price if the base rate rises.

A 0.25 percentage point hike in mortgage rates will add £20 to monthly payments (£240 a year) on a typical £150,000 repayment mortgage at 3% interest (rising to 3.25%). A 1 percentage point rise on the same mortgage will add £81 to monthly payments (£972 a year).

Melanie Bien, from broker Private Finance, says: "While no one knows for sure when interest rates will rise, the reality is that it will happen at some point so a wise borrower should be prepared.

"Look at your own circumstances. If rates were to rise, could you afford the mortgage? If not, you should consider a fixed rate.

"They are unlikely to get any cheaper; indeed, as a rate rise looks more likely, fixes will become more expensive."

Want to fix? How long for?

Hollingworth adds: "If you fix for five years, as these are more expensive, you may pay more over the first few months or years, but you would benefit, if the CBI is correct, in the long run.

"A two-year fix will be cheaper but then you need to consider what to do when it expires when rates could be higher."

What about variable rates?

Those who want to gamble on rates staying low can choose a variable deal which tend to be cheaper than fixes initially. With these, you can also reserve the rate for a few months.

Further reading/Key links

Mortgage cost-cutting guides: The Remortgage Guide, First-time Mortgage Guide, Cheap Mortgage Finding, Ditch My Fix? Get help: Mortgage Arrears, Redundancy Help