Discount deals flourish as Bank holds its hand on interest rates

The fix has died, long live the discount. Homebuyers are ditching fixed rate loans in favour of discount mortgages in the belief that, after this week's Bank of England decision to keep base rates on hold, interest rates will soon peak, then begin marching down again by 2002.

Halifax has unveiled a new range of discount mortgages which brokers say are among the best currently available. For first time buyers able to stump up a 25% deposit, it is offering a two-year discount of 2.05% off its current standard variable rate of 7.74% to give a rate of 5.69%.

The smaller the deposit, the smaller the discount. For loans of up to 97% of the value of the house, the discount will be 1.99% for two years. Neither loan has lock-in penalties, which means that even if you quit during the discount period you won't face a repayment fee.

Note the 97% maximum. Only last week, Halifax raised its maximum "loan to value" from 95% to 97%, provoking concern that rising house prices plus competition among lenders is encouraging home buyers to stretch themselves to affordability limits.

The higher loan limits also come with a sting in the tail. Borrowers who put up a deposit smaller than 10% of the value of the house will usually have to pay a mortgage indemnity premium, which in the case of a £100,000 loan can cost around £1,700.

Abbey National also unveiled a 2% discount mortgage, giving an initial rate of 5.74% and no exit penalties if you pay a booking fee of £195. The minimum deposit, however, is 10%.

Siobahn Hotten of brokers John Charcol says homebuyers are spurning fixed rate deals in favour of discount loans. "In some ways it's quite odd. Historically people have jumped into fixes when they expect rates to rise. But this time they're opting for discounts, partly because they don't have redemption penalties but mostly because the rates are so much better than the fixes now on offer."

For example, Halifax's current two-year fix is 6.19%, or nearly half a per cent above the discount rate, plus you have lock-in penalties during the term of the fix.

Of course, rates could shoot up, leaving all those on discounts wishing they had taken a fix. One way to avoid that problem is to take a "discount plus cap" loan, which limits the maximum rate that you will pay on the mortgage. John Charcol is offering a deal it has agreed with Yorkshire building society where the maximum interest rate charged will be 6.99% over the next five years.

Northern Rock is also offering a capped rate of 6.3% for two years with a £500 cashback. Redemption penalties apply in the first two years.

A further approach to second-guessing future moves in interest rates is to look at tracker mortgages.

These follow base rates up and down, usually in the form of base rate plus 0.5-1%. Understandably these have not been popular in recent months as rates have risen and are expected to go higher. But this week Legal & General issued a tracker which is charged at 0.79% over base rate, giving an initial pay rate of 6.79%, which is then further reduced by a two-year discount, taking the rate to just 6.09%.

The main advantage of the tracker concept is that you are guaranteed that when rates do start heading south, your lender will pass on the difference immediately rather than passing on just small cuts as happens frequently.

The only catch with the L&G loan is that you have to put up a 25% deposit. For deposits smaller than 25%, the start rate is 6.29%.

What do the experts predict will happen with interest rates? City investment bank Salomon Smith Barney this week said that it believes the prospect of the UK joining the euro is "receding to the distant horizon", so there is little chance of a lurch down to interest rates common among the European countries.

Its forecast is that base rate will rise from 6% to 7% by the end of this year and hit a peak of somewhere between 7% and 8% in 2001.

If so, that will result in a Halifax standard rate of 9.75%. So don't hang about - bag yourself a deal quick while the going is good.