The peculiar rate reduction

The Bank of England's Monetary Policy Committee has cut Bank rate from 5.25% to 5%. This is the third quarter-point reduction since December and many economists believe there could be more falls to come before the end of the year.

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However, because of the ongoing funding shortage banks and building societies are facing, the usual round of mortgage and savings rate reductions may not transpire. In fact, those looking to buy a property or needing to remortgage in the coming months are being warned to prepare for higher mortgage rates.

Nationwide, Alliance & Leicester, Woolwich and Abbey have all increased rates on some of their mortgage products in recent days. The reason for this is impact of the credit crunch: financial institutions are struggling to raise money for loans and because of the shortage of liquidity in the wholesale money markets, lenders are having to pay more for the funds that are available. Consequently, the cost of wholesale borrowing is significantly higher than Bank rate, and this is why mortgage rates are still climbing at a time when the country’s official rate of interest is falling.

Pressures set to continue
The MPC’s decision to cut Bank rate may ease things slightly for lenders, but the problems in the wholesale markets are far from over and many economists believe the credit crunch could get even worse before the situation starts to improve.

Brokers therefore expect lenders to continue re-pricing and pulling their mortgage deals frequently. Louise Cuming, head of mortgage services at moneysupermarket.com, said: "Consumers must remain on their guard and anyone looking for a mortgage should jump on attractive deals immediately, as they won’t stick around for very long."

It’s not all bad news for borrowers
Existing borrowers with tracker rate mortgages will see their monthly payments come down following the rate cut as trackers move in line with Bank rate. This means someone with a £150,000 interest-only mortgage will pay £31 a month - £372 a year – less as a result of the quarter-point reduction.

Many of those paying their lender’s standard variable rate (SVR) will also benefit from the full cut: Halifax, Woolwich, Nationwide, Abbey, HSBC and Cheltenham & Gloucester are among the providers to have already announced that their SVRs will fall by 0.25 percentage points.

However, if you are paying your lender’s standard rate or have a discounted mortgage deal that is linked to SVR, there is no guarantee that you will see your rate fall by the full 0.25 points. Any changes are at the lender’s discretion and given the funding difficulties many are facing, some may decide not to pass on all of this month’s reduction.

When Bank rate was last cut in February, around 20% of lenders chose not to reduce their SVR by the full amount: Northern Rock cut its SVR by just 0.1 percentage points, while Britannia building society’s rate went down by only 0.15 points.

Analysts expect a higher number of lenders not to reduce their SVR by the full amount this time around.

What are the best deals currently available?
If you believe interest rates will fall further, you may want to go for a tracker. Chelsea building society has the best two-year rate at 5.34%. This deal is available for loans up to 90% of the property’s value and there is no early redemption charge. However, the fee is high at 2.5% - someone borrowing £150,000 would have to pay £3,750 just to set the loan up.

A more attractive option for those remortgaging is perhaps HSBC’s lifetime tracker at 0.38 points above Bank rate, giving a current pay rate of 5.38%. The arrangement fee on this deal is £599. Alternatively, HSBC is offering a rate of 0.74 points above Bank rate – currently 5.74% - to those buying a property. While the rate is slightly higher on this product, there is no arrangement fee. Both deals are available for loans up to 90%.

While most economists expect interest rates to fall further this year, some borrowers will prefer a fixed rate mortgage because they like the security of knowing exactly what their mortgage payments will be each month.

Cheshire building society has the best two-year fix at 5.49%. There is a £999 arrangement fee and although the deal is available for loans up to 95% of the property’s value a higher lending charge, which is effectively an insurance that protects the lender against negative equity, is levied if your deposit is less than 10%.

You can actually benefit from a lower rate if you are prepared to be locked in to your mortgage for a longer period. HSBC has just launched a new five-year fix at 5.39%. Available for loans up to 90%, the arrangement fee is £999.

If you are coming to the end of your current fixed rate deal and are worried that you may have to remortgage on to a significantly higher rate, there may be no need to panic. HSBC is clearly looking to increase its share of the mortgage market at the moment, because it is launching a special offer, whereby it guarantees to match your current fixed rate for the next two years.

There are catches: the offer, which is available from April 14 until May 18 2008, only applies to borrowers whose fixed rates end before June 30 2008. The lowest rate it will match is 4.54%, while the maximum loan size is £250,000 and borrowers must have at least 20% equity in their home.

If you are eligible, this is a great offer. However, demand for this promotion is likely to be huge so be warned: it may take longer than normal for your application to be processed.

If you are unsure about what type of mortgage to go for, call one of our advisers on 0845 345 5705.

What about savers?
The rates on many savings accounts will fall following this month’s Bank rate reduction. In fact, a few providers including Egg, have already announced that they are passing on the full 0.25 point reduction.

However, savers should still be able to benefit from some highly competitive deals. Because of the liquidity shortage, many institutions are seeking to pull as much money into retail deposit accounts as possible to reduce their reliance on the wholesale funding markets. As a result, savers can choose from a raft of deals paying in excess of 6% and this is likely to continue.

Kevin Mountford, head of savings at moneysupermarket.com, said: "Savers really are in the enviable position of being able to pick and choose where they stash their cash. But as ever, you need to check the terms and conditions carefully, as many of the high rates include short-term bonuses or withdrawal restrictions."

Abbey has actually just increased the rate on its E-Saver Direct account, by 0.25 percentage points taking it to 6.50%. However, while this is an easy access account, you are penalised if you make a withdrawal: you receive just 2.75% in any month a withdrawal is made.

Alliance & Leicester’s Esaver account also pay 6.50% but you earn no interest at all for the month in which a withdrawal is made, with the exception of July when penalty-free withdrawals are permitted.

Neither Abbey nor A&L have yet announced changes to their savings accounts following the rate cut, so the rates on these accounts may fall. However, Kaupthing Edge, the Icelandic bank, has announced that the rate on its instant access account will remain unchanged at 6.50%. Another plus point about this deal is that you can make unlimited penalty-free withdrawals and there is no introductory bonus

Other leading catch-free deals include ICICI’s Hisave account and Bradford & Bingley’s Internet Saver 2 account. They pay 6.16% and 6.15% respectively, although these could fall as neither bank has yet responded to the rate cut.

If you are prepared to lock your money away, you can earn an even higher rate of interest: Kaupthing Edge’s one-year fixed rate bond is paying 6.86% on balances above £5,000, while Bradford & Bingley’s Fixed Term Bond 28 has a rate of 6.81% that is fixed for six months. With interest rates set to fall further, now could be a great time to fix your savings.

Disclaimer: Please note that any rates or deals mentioned in this article were available at the time of writing.

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