Is mortgage insurance a better bet than a fix?

Worried mortgage holders who want to cap their costs following the news over a million are set to be whacked with massive hikes have an alternative to simply taking out a new home loan.

Many will opt for a fixed rate mortgage, but a company called MarketGuard offers an insurance product, RateGuard, that caps your rate, meaning you won't pay more than the agreed limit, even if rates soar.

Here, we look at the pros and cons of the scheme given there are many opposing views.

Brokers, for instance, warn it is not for everyone, but it can be a help for mortgage prisoners who cannot switch deal because they don't own enough equity in their property or their credit history is poor.

There are limits to when the insurance will pay out. For instance, it will not necessarily cover you if your lender ups your mortgage rate simply to boost its profits.

Instead, it must follow a rise in base rate or a key inter-bank lending rate.

Earlier this month, Bank of Ireland, Clydesdale/Yorkshire Bank, Halifax and RBS all announced rises in the cost of many of their existing customers' standard rates. Over one million borrowers will be hit by these jumps.

Some of these customers with insurance will not be covered in full such as borrowers who took insurance since last summer, though others will.

How does the insurance work?

Here are the key points:

• You pay a monthly insurance premium which buys you a cap on your mortgage rate. Quite simply, if the rate exceeds the cap, you do not pay the difference between the cap and the new rate.


• The cap can be set either at your current rate, or at 0.5% or 1% above that rate. For example, if you pay 4% now and want to cap your rate at 1% above, you will pay more each month if the rate rises to anything up to 5%. Once it goes above 5%, you don't pay any more than what you'd pay at 5%.


• You can cap your rate for either two or three years.

What does it actually cover?

• The policy will only pay out if your lender raises costs following either a Bank of England base rate rise or a rise in the three-month Libor rate. This is the inter-bank borrowing rate that plays a big part in determining the cost of variable mortgages.
  
  MarketGuard will compare the base rate or Libor at the point you took your policy with the level when your mortgage rate rises. If either the base rate or Libor rise by less than the rise in your mortgage rate, you will not be covered in full.

• You can only insure against an unknown rise. So, for example, if you are on a fixed or tracker linked to the base rate, and you know that at the end of the deal your rate will rise, the policy will not pay out for that increase.

So what's the proof in the pudding? Will Market Guard pay out on recent rate rise announcements?

There is no universal answer. It depends when customers took out a policy.

The base rate has not moved from its 0.5% historic low for over three years, but Libor has moved over the past few months.

It's a 'yes' for Clydesdale/Yorkshire, Halifax and RBS customers who took out a policy last summer. Their 0.36% Clydesdale, 0.49% Halifax and 0.25% RBS rises in March or May will be covered in full.

Customers who took out a policy more recently will see a "smaller payout", MarketGuard says.

There is no answer yet for Bank of Ireland customers, given the 1.5% rise is still months away.

How much does cover cost?

The cost varies wildly depending on your rate, the amount and length of the cap and the mortgage debt.

The table below gives some examples:

To work out if this is a good deal compared to fixing, you need to compare against the cost of setting up a fixed rate mortgage and any change in your monthly payments as a result of switching home loan.

It can often cost £1,500 in fees for a new deal, though much higher and much lower charges are possible.

Also consider that you may pay any increased costs on your existing deal up to the cap, even with insurance.

How are you paid out?

You still make your mortgage payments as normal, but MarketGuard will deposit funds into your account before your payment is due to cover any rises.

You don't need to make a claim. The cash will arrive automatically as MarketGuard is in touch with mortgage lenders so it knows when they raise rates.

Is your money safe if MarketGuard goes bust?

The company stresses it is covered by the Financial Services Compensation Scheme, meaning 90% of any claim is guaranteed.

How MarketGuard sells its product

MarketGuard, which largely aims its product at the millions sitting on their lender's standard variable rate, says its insurance is often cheaper than getting a new fixed rate mortgage.

This is because the monthly premiums over the term of the cover can be lower than the cost of getting a new home loan, which includes the mortgage application fee and any legal or valuation charges.

What's more, some homeowners may not qualify for a new mortgage at all if they have a poor credit score, or if they don't have sufficient equity in their property.

To get a mortgage you normally need to own at least 10% of the property outright. To get a decent rate, you normally need 25%.

Equity and credit score are not an issue when getting a RateGuard policy.

So what's the catch?

Crucially, the insurance may not actually pay out even if your lender ups its rate, for the reasons stated above. It also doesn't always cost a great deal to switch mortgage.

In addition, if you are on a higher than average rate now, a new mortgage may be significantly cheaper.

So what's the verdict? Is it worth it?

Here's what one highly-respected broker, David Hollingworth, from London & Country, thinks: "The company makes some big assumptions, yet you don't necessarily have to pay high arrangement fees. You can also side-step valuation and legal costs on remortgaging anyway.

"Some pay a 4.5% or 6% SVR so remortgaging, rather than insurance, can save them quite a bit of money.

"And as you can't fix for that long with MarketGuard, it may not be good for those who want a five-year fix, which many people seek.

"Where it is good, is where you cannot get a mortgage if you don't have the equity or a good enough credit score."

Should you fix in the first place?

Only you can answer that question. It's down to your attitude to risk and whether you can afford a rise in your payments (see the Fix vs Discount Mortgage guide).

Often, it is best for those who require the surety of guaranteed payments.

None of us have a crystal ball so we can't say with any certainty whether rates will rise or not.

As the mortgage market is complicated, the best route is to use a 'whole of market' Mortgage Broker to talk you through the options.

Then supplement this with searching the best buy tables, as brokers often can't help with some deals that are only available direct from banks or building societies.

If you have no choice but to swallow increased rates, then use our Free Budget Planner tool to help keep spending in check after a rise.