Why fixed rates have not proved a snorter

Higher mortgage payments are on the way for millions, with Abbey National and Nationwide among the latest lenders to announce they will be upping their home loan rates by at least 0.25%.

The February 10 Bank of England base rate rise was the fourth in six months, and economists say there is more to come. However, if you think you've got it bad, spare a thought for the tens of thousands of homeowners who are seeing their monthly mortgage bills double at a stroke.

These people took out cheap two-year fixed-rate deals back in early 1998 - a time when severe storms were battering the south coast, Titanic star Kate Winslet was up for an Oscar and the second of the Tamworth Two runaway pigs was being recaptured- in some cases, the rate they paid was fixed at 4% or even less. But now the fixed rate period is coming to an end and they are suddenly being plonked on to their lender's standard variable mortgage rate - typically around 7.74%. In hard cash terms, that could mean a borrower with a £100,000 interest-only mortgage could see the amount they shell out rising by more than £300 a month. Over a year that's getting on for £4,000 extra.

Most of these deals carry early redemption penalties for up to five years, which means borrower are stuck on the variable rate until perhaps 2003. Unless they can persuade their lender to let them move on to another fixed or discounted rate, their only means of escape will be to pay the redemption penalty in some cases several thousand pounds.

What are the various options for homeowners in this position? To analyse what's gone wrong it is necessary to turn the clock back to the start of 1998. Back then, the base rate stood at 7.25% after having risen five times in 1997, while the typical standard variable mortgage rate was 8.7%. The view of many commentators was that mortgage rates would start falling as the UK prepared to join the euro and could go as low as 5% in 2000. So taking advantage of one of the many cheap fixed-rate deals seemed to make perfect sense.

However, things didn't turn out as the economists predicted. Interest rates did fall, but then they started rising, and the standard variable mortgage rate is now close to 8% and showing no signs of stopping there.

A borrower who took out a £100,000 loan fixed at 3.99% for two years and is currently paying £332.50 a month will see this shoot up to perhaps £645 a month when they move on to the standard variable rate. Some homeowners will be able to absorb this huge leap in costs, but for others it will put "an enormous strain" on the family's finances, says Simon Tyler at mortgage brokers Chase De Vere Mortgage Management.

If you think you fall into this latter category, the first thing to do is check exactly what the redemption penalties are. If you are not locked in you should be looking to move to another lender's better deal without delay.

If there are penalties, talk to your lender to see if there are any other products they will let you switch into. If that doesn't work, there are other options. One is to consider paying the redemption penalty so you can move to another lender's deal. You will need to work out whether you would be better-off staying or going once the costs are taken into account, says Simon Knight at mortgage brokers Independent Mortgage Collection.

Sometimes there will be little in it. Take someone with a £100,000 interest-only loan whose two-year fixed-rate period has come to an end this month and is locked into the lender's standard variable rate (currently 7.74%) until February 28 2002. There is an early redemption penalty of six months' interest at the prevailing variable rate.

If they stick with the deal until the end of the lock-in period they will pay a total of £15,480 in mortgage payments. But if they moved to a good-value two-year fixed rate such as one offered by Yorkshire Building Society - 5.89% with no penalties after the two years - their total outlay over the two years would be £11,779. But they will have to pay the redemption penalty, which here would be £3,870, and when this is added to the amount the Yorkshire would charge it gives a total of £15,649.

If the sums work in your favour but you can't afford to pay the penalty and you think you're not going to be able to afford the higher payments once you move on to the standard variable rate, you could still go down the remortgage road but add the redemption charge to your new mortgage. So if you need a loan of £50,000 and are stuck with a redemption penalty of £2,000, you borrow £52,000 from your new lender. If this is the only way you can remortgage it is worth considering.

The worst thing is to do nothing, says Ray Boulger at mortgage broker John Charcol. You could end up in arrears - and then you may have difficulty obtaining a mortgage in future.