The big rate rise gamble

With interest rates at historic lows, many first-time buyers are going to be tempted to mortgage up to the max - but what happens if rates rise?

Millions of homeowners breathed a sigh of relief this week after the Bank of England decided to keep interest rates at a 48-year low of 3.5%.

But their happiness may be short-lived. Pretty much every economist reckons the next move will be up, and some predict that in two years the base rate could be 5%. If that forecast proves to be correct, it would mean a borrower with a £100,000 repayment mortgage, on a typical base rate tracker deal, would be forking out £644.30 a month (see table).

That's £88 more than the £555.83 a month being paid by someone with a base rate tracker where the rate paid is base rate plus 1%.

We asked a few economists where they see interest rates going.

Adam Chester, chief economist at Halifax Bank of Scotland treasury services, reckons we will end the year at 3.5%, with the base rate rising to 4% by the end of 2004 and 5% by the end of 2005.

Alex Bannister at rival lender Nationwide forecasts the base rate ending next year at 4% or 4.25%, with the rate settling at around 4.5%-5% after that.

Meanwhile, Stuart Block at fund manager Schroders says there is a pretty good chance of a rise next month. Some people taking out a mortgage will be happy to take their chances. Others, particularly those on tight budgets, will be keen to cushion themselves from any nasty shocks by opting for a fixed-rate mortgage.

Ray Boulger at Charcol says that as a result of the money markets pricing in substantial base rate rises, most fixed-rate deals continue to look expensive compared to their discount and tracker counterparts.

"With the value margin so wide between trackers and fixed rates, we would advise most borrowers to plump for a market-leading discount or tracker," he says.

A deal on offer from Charcol, and some other brokers, gives borrowers a 2% discount for two years to give a current pay rate of 3.54%, plus 1% cashback. Minimum deposit is 5% and there are fees of £344, plus you may have to pay a broker fee. There are redemption penalties for two years.