MONEY COMMENT
How Low Can Mortgages Go?

By Cliff D'Arcy
May 22, 2003

About four years ago, my wife and I decided to fix our mortgage to take advantage of the low fixed-rate deals available at the time. Our lender, Abbey National (LSE: ANL) was offering a market-beating interest rate of 6.25% fixed for ten years, which was roughly equal to the base rate at the time. As our mortgage was relatively small (especially in London terms), we were happy to fix and have the security of knowing exactly how much our next 120 monthly payments would be.

As things turned out, this was a pretty good call for the first three years. The Bank of England kept base rates between 5% and 6% in 1999 and 5.75% and 6% in 2000. However, it cut rates throughout 2001 and, after the September 11 attack, base rates slid to 4%, before dropping to 3.75% this February.

Anyway, as soon as Abbey National's standard variable rate fell to below 6.25%, we decided it was time to buy ourselves out of our fix. We paid a whopping penalty (ten months' interest, equal to 5.2% of our loan - ouch!) and switched to a base-rate tracker mortgage, on which we now pay a mere 4.5%.

As it turned out, the money we saved between 1998 and 2002 was more than our redemption penalty, so it was all square between Abbey National and us. We're now planning to switch again - this time without penalty - probably to a cheaper tracker or a discounted-rate loan, as I expect interest rates to remain low for the foreseeable future and would like to take advantage of any further rate cuts.

However, a mortgage available from 23 May from the Newcastle BS caught my eye. It is a five-year fix at 3.95%, which includes a completion fee of £345 for loans under £250k. This is only 0.2% above the current base rate, which may prove very attractive to new and existing borrowers looking for steady payments until July 2008. To put this deal into context, it is replacing a previous five-year rate of 4.39%.

Obviously, the Newcastle expects to make money from these loans, which suggests that it expects base rates to continue to fall. Last month's Monetary Policy Committee meeting (MPC) was split 5-4 against a rate cut, so it's even money that rates will come down again - possibly as early as next month, especially with inflation expected to fall below 3% shortly.

So, how low can mortgage rates go? We could assume that the best mortgage lenders can make a living by charging a margin of only 0.75% over base rates. So, here's what might happen if UK rates fell to the same level as those in the following regions:

Country   Base rate                  Base +0.75%
Japan     0.1% since September 2001        0.85%
USA       1.25% since November 2002           2%
Eurozone  2.5% since March 2003            3.25%

Alas, it's unlikely that the UK will see the near-zero interest rate of Japan, which is a response to a severe economic problem (falling prices, also known as deflation). Also, the US has usually maintained its interest rate below those of the other leading industrial nations, so we probably won't see mortgage rates of 2% quite yet. Even so, variable rates in the US at the moment are around 3.75%, not that much lower than those we have in the UK. Many US homeowners take out 15- and 30-year fixes, currently costing around 5% and 5.5%. 

It's quite possible that, if our economy slows down, the MPC could cut the UK base rate to 2.5%, which would mean the lowest mortgage rates for two generations. For now, borrowers should keep their fingers crossed and await the monthly decisions from the MPC.

More: Mortgage Centre | 21st Century Mortgages | Economic Analysis discussion board.