Don't get locked in

With interest rates at their lowest for 50 years, homebuyers have the pick of some of the best ever mortgage deals. As lenders, desperate to attract homebuyers and remortgage business, cut rates in a fiercely competitive market, there are few reasons for anyone to pay the standard variable mortgage rate (the rate on to which a bank or building society will generally move you once your fixed rate or discounted deal comes to an end).

Standard variable rates stand at 5.5% or more with major lenders. At Halifax the rate is 5.5%, and at Abbey National 5.54%, which is a huge 2% margin over the 3.5% Bank of England base rate.

But borrowers looking for better deals need to look carefully behind exceptional headline rates because they could end up paying more in the long run. Lenders find ingenious ways to offer deals that look extremely good on the face of it but hide nasty surprises in the small print.

On variable rate loans, for example, lenders might impose a minimum level you pay however low the base rate falls, while on other deals you may be locked into paying the high standard variable rate for years after the original deal ends. Watch out too for hefty upfront charges.

Redemption penalties

The redemption penalties you have to pay if you cash in your loan during a certain period can cancel out the effect of an exceptional headline rate. It is reasonable to expect to pay a fee if you cash the loan in during the fixed-rate period, but avoid deals that entail paying a fee to get out once this period has ended.

David Hollingworth, adviser at mortgage specialist London & Country, warns: "A redemption penalty that lasts beyond the initial deal effectively locks you into paying the standard variable rate and is one of the easiest ways lenders can offer low headline rate deals. You need to be wary of these."

Mark Harris, managing director at mortgage specialist Savills Private Finance, agrees: "These products should be avoided. There is no reason to pay the standard variable mortgage rate. They open up problems for the future."

Some lenders with 'overhang' redemption penalties, which run past the original low-cost deal, are offering two-year fixed-rate deals of below 2%, but you could end up paying the standard variable rate for a further four years. If you want to get out it can cost you as much as 7% of your loan - or ?7,000 on a ?100,000 loan.

This 2% compares with top 'clean' fixed-rate deals - where you are free to move once the initial low-cost fixed-rate period has come to an end - of around 3.5%. Britannia charges 3.49% and Portman Building Society 3.59% for clean two-year fixed-rate mortgages. Portman also charges 1.19% on its two-year overhang fixed deal, which has redemption penalties lasting for six years in total.

Less significant, but still important, are arrangement fees. These can be between ?150 and ?250 at the low end, rising to ?400. If the fees are more than ?250, factor them into the cost.

Some deals look better at second glance as the lender pays the cost of valuing the property, along with legal and arrangement fees totalling ?1,000 on average.

How low will it go?

The base rate has fallen by 0.5% this year, but many borrowers on discounts linked to the standard variable rate have not benefited to the full extent. Abbey National has lowered its rate by 0.4%, Halifax by 0.25%, and Woolwich has knocked 0.41% off its rate.

However, borrowers with tracker mortgages - where the rate moves in line with the base rate - have seen the whole 0.5% fall feed through to their payment rates. These loans continue to look attractive if, as many commentators expect, the base rate falls further.

Some deals track the base rate for the life of a loan. But watch out for those that only track it for a couple of years before switching back to the standard variable rate. At this point you need to remortgage.

More recently, some lenders have introduced a minimum rate on their tracker mortgages below which your rate will not fall - known as a collar - and others could follow suit.

Research from mortgage broker Charcol shows a number of trackers are close to their collars. Halifax, for example, reserves the right not to follow the base rate down further than 3%. Darlington Building Society has a collar of 3.49% on some of its mortgages, and National Counties has collars of 3-3.15%. Other lenders with a 3% collar include Lambeth, Mansfield, Marsden, and Norwich & Peterborough.

"These collars detract from the key reason for having a tracker mortgage: to benefit from the full fall in base rate," says Ray Boulger, senior technical manager at Charcol. Boulger picks out Newcastle building society, Abbey National and Woolwich as good life-time trackers without collars.

Newcastle has a lifetime discount at base rate plus 0.5% for the mortgage term with no collar. Abbey National's tracker is at base rate less 0.36% for two years, while Woolwich tracks the base rate for two years, then base rate plus 0.85% for life.

If you go for a tracker, you need one with friendly early redemption terms so that you have the option to move once the base rate starts to climb.

Mortgage indemnity guarantee premiums

Most, but not all, lenders charge a mortgage indemnity guarantee (MIG) premium if you have a deposit of less than 10% of the value of your home. This insurance premium does nothing for you but pays for insurance for the lender - if you fail to pay your mortgage payments, it can make a claim. "This charge can add well over ?1,000 to your costs," according to Hollingworth. "On a two-year deal, it can add up to 0.75% to the headline interest rate."

You pay this premium with Abbey National if you borrow 90% or more of the value of your home. On a ?100,000 mortgage where you are borrowing 95% of your home's value, the premium comes in at a hefty ?1,684.

The cost of the premium (also called the high loan to value fee) is not the same with all lenders, but it is generally between 7% and 8% of the money you need to borrow between 75% and 90% of the loan. You typically have the choice of whether to pay the MIG up front or add it to your loan.

Harris says: "The MIG premium is an unnecessary evil. It makes comparing products difficult. Look at deals that do not make such a charge if you are borrowing over 90% of the cost."

Leading lenders that do not charge a MIG premium include Nationwide, Northern Rock, Cheltenham & Gloucester, Intelligent Finance and Standard Life Bank.

For this month's best mortgage deals use our daily updated Compare and buy service.

· This is an edited version of a piece that first appeared in this month's Money Observer magazine. To find out more about Money Observer, or to subscribe online, visit moneyobserver.com.