Low meant a dream home: high is a nightmare

Rising interest rates are already having a devastating effect on some homeowners. Borrowers who took out discount deals with exceptionally low start-up rates are seeing repayments increase by as much as three times the original amount. Debt charity PayPlan says that counsellors are beginning to see clients who are finding themselves in serious financial difficulties as a result of soaring borrowing costs.

Some even face bankruptcy and repossession because they cannot cope with the increased cost of their mortgages after low initial rates end.

This comes at a time of increasing concern over rising levels of indebtedness. Bank of England statistics last week confirmed that Britain's total personal debt, including mortgages, personal loans and credit cards, could reach £1 trillion by this week.

Millions of homeowners have taken out discounted rate mortgages in recent years. These have helped to fuel activity in the booming housing market by keeping monthly payments low in the first year or two after a borrower buys a property. Lenders say they make the terms clear and also test borrowers' ability to repay at the higher rate, but they could be open to accusations of mis-selling if borrowers say they were not made aware of how payments could rise.

The mortgages causing problems are those which charge a very low initial rate of between 1 and 2 per cent. When this ends, borrowers find they are locked into the lender's much higher standard variable rate by hefty penalties. The cost of standard variable rate loans is rising and is set to increase further (see below).

John Fairhurst, chief executive of PayPlan, says borrowers are seeking help from the charity to fend off creditors and reschedule debts after their payments have increased. In some cases, monthly mortgage costs have tripled overnight.

'These problems tend to occur where someone has had to stretch their mortgage to afford their property, then used unsecured credit to furnish their home,' he added. 'When the interest rate rises, the combination of the two puts incredible pressure on their budget.'

Diane Watson, a PayPlan counsellor, says that 20 per cent of her clients face mortgage payment problems. 'Whereas people were paying £200 or £300 a month, we're seeing people facing payments of £700, £800, even £1,100 a month.'

She says that borrowers become trapped in a vicious cycle: because they have missed payments on their mortgage, personal loans or credit cards - and possibly incurred county court judgments - their credit rating plummets. Then, when they try to remortgage to consolidate their debts, they are charged a premium rate by their new lender because they are deemed high risk. This often means they cannot afford their mortgage payments and need to continue using their credit cards, building up further debt.

Watson says that in some cases the creditors, often the Inland Revenue and Customs & Excise, petition to make the debtor bankrupt so that their assets - usually their home - can be seized.

'For someone in this position, we recommend they sell their home themselves so they keep control of the money, pay off their debts themselves and even come out with some cash in their pocket.

'It's very harsh - this is their home we're talking about - but if their property is repossessed it is often sold at auction for less than you'd get through an estate agent. It may not even fetch enough to clear their debts.'

Several lenders still offer deeply-discounted loans, including the Portman Building Society and Northern Rock bank. Northern Rock's offering charges 1.98 per cent for the first two years, but rises to its standard variable rate (currently 6.29 per cent, but which could be higher in two years' time).

The loan has redemption penalties which continue for five years beyond the low rate period, costing from 8 to 2 per cent of the outstanding mortgage. Someone repaying a £100,000 loan in the second year would have to pay £8,000 in penalties.

Portman Building Society has a deal starting at 2.29 per cent rising later to the equivalent of bank base rate plus 1.99 per cent. At current rates the long-term cost of borrowing on this deal would be 6.24 per cent.

But a Portman spokeswoman says this is made 'crystal clear' to borrowers at the outset. When selling the loans, the society looks at applicants' ability to repay at the higher as well as lower rate. There is no evidence, adds the spokeswoman, that any are experiencing difficulties with these mortgage deals.

Ron Stout, a spokesman for Northern Rock, says: 'We offer these mortgages because customers still want them. I'd have to say that fewer customers are going for them, but sometimes they fit the bill exactly.'

He adds that Northern Rock's lending criteria are designed to ensure that borrowers can afford their loans at both the lower and the higher rates.

David Hollingworth, of independent mortgage broker London & Country, says he would be amazed if his firm had ever recommended this type of mortgage deal. 'You're being lured in by a carrot on a stick with these products,' he said.

Whatever the MPC does, you'll pay

Homeowners face further mortgage rate shocks, with lenders expected to pass on in full the next interest rate rise from the Bank of England. This could mean borrowers paying an extra 0.25 per cent from the start of July if the Monetary Policy Committee pushes up the rate by that amount after its next meeting on Wednesday.

'Lenders have been responding to interest rate rises by putting up mortgage rates,' said Martin Ellis, chief economist of the Halifax. 'That pattern would continue.'

Although there could be the odd exception, it is unlikely at this stage since further rises are expected. The Council of Mortgage Lenders is predicting a 5.25 per cent base rate by the end of the year, 1 per cent higher than now. Nationwide predicts a 4.75 per cent rate by the end of 2004. Such expectations would suggest standard variable mortgage rates of about 6.5 to 7 per cent because mortgage rates are currently about 1.5 to 2 per cent higher than base rate.

On calculations produced by Nationwide, a homeowner with a £100,000 25-year repayment mortgage could see monthly payments increase by nearly £80 over the next year. On the current typical standard variable rate of 6.25 per cent, they would pay £659.67, but this could rise to £706.78 if their mortgage rate goes to 7 per cent or to £739.00 should it rise to 7.5 per cent.

Home help

PAYPLAN'S advice is free. To contact the charity call 0800 085 4298 or visit www.payplan.com.

London & Country will calculate for free whether it is cost-effective for borrowers to pay the penalty and remortgage - call 0800 373300.