Borrowers beware, even if rates do fall

Although the base interest rate was not reduced last week, economists expect a cut soon. So which mortgage should you apply for - a fixed or discounted rate?

A discount mortgage, that tracks the Bank of England's base rate at a level below the lender's standard variable rate, seems tempting if interest rates fall.

But borrowers should think about what they want before choosing a large discount over a fixed-rate product. One disadvantage of discounted loans is that their interest rate can go up as well as down.

Phillip Cartwright, of Bath independent mortgage broker London & Country, advises you to consider the worst: 'Look at how your repayments would be affected if rates went up by one per cent. Could you still afford to keep up with repayments ?'

Another disadvantage of discounted mortgages, according to Cartwright, is that lenders do not always pass on reductions in full when there is a base rate cut. This is why London & Country is recommending tracker mortgages which feel the benefit from any drop in interest rates straight away. The broker favours Halifax's tracker which is set at 0.45 per cent below the base rate until the end of 2002 giving an initial rate of 5.55 per cent for up to 75 per cent of the value of the house. It is penalty-free. For larger loans, Principality and Scarborough both offer trackers.

London broker Charcol recommends Birmingham Midshires 2.5 per cent discount over two years which takes the lender's standard variable rate down to 5.24 per cent, but you will be stung with a penalty of 3 per cent if you want to remortgage in this period.

If you are borrowing the maximum and need to know exactly how much you will be paying, you may be better off with a fixed rate.

Should rates drop during the fixed period, you have the option of switching to a mortgage with a lower rate, although it's important to choose a loan without a redemption penalty if you are really to benefit. Siobhan Hotten, of Charcol, recommends Yorkshire Building Society's two-year fixed-rate mortgage at 4.99 per cent which has redemption penalties during the fixed period.Borrowers can take out loans worth up to 75 per cent of their property's value. Hotten says: 'The base rate would have to go below 3 per cent to make it poor value.'

Another fixed-rate mortgage Charcol favours is from GMAC (a subsidiary of General Motors) which charges 5.49 per cent until March 2003; it has no redemption penalties at any time. At this rate, borrowers can take up to 75 per cent of their property's value - the rate rises to 5.69 per cent if they borrow 95 per cent.

Capped-rate mortgages are often touted as offering the best of both worlds: security and the potential to pass on a drop in rates. There is no limit to how much the rate can fall but there is a 'cap' on rate rises. But Hotten says it is a good idea to compare any capped-rate mortgage to fixed-rate products, as you may be paying for something that never comes into effect.