Your Buy To Let Mortgage - Fixed Or Variable Rates

Making the choice between a fixed or variable rate Buy To Let mortgage is always difficult, and at the current time, more challenging than normal. This article is designed to help you select the right product.

Firstly, we do not face a 'normal' BTL mortgage market. With Bank Base Rate (BBR) at 0.5% most Buy To Let borrowers are paying from 4% to 7% for their funds. Both fixed and variable rates are extremely high in relation to BBR in historical terms. We all know why that is - the credit crunch, but the Government's policy of Quantitive Easing will have pumped £200bn into the economy by early 2010 and is designed to increase the money supply and reduce the shortgage.

This is important, because if it is successful then we may see more competition between banks as the easier availability of money enables rates to fall.

So here's the first point. If you think this is likely to happen and the bank's margin is to reduce, then the worst thing you could do is lock yourself in to an artifically high fixed rate right now!

Now let's consider when base rates will increase and by how much. Another crystal ball is needed, but whilst the economy is still in poor health - recession even - it's doubtful if the Government wants to increase the cost of borrowing to industries and possibly cause a 'double dip' and another fall in house prices.

Most commentators think that rates are going to stay low certainly into 2011.

Here's a table which gives you an insight into the future:

This shows the 6 month LIBOR rate into 2010. If you don't know, LIBOR is the London Inter Bank Offering Rate and it's the interest rate at which banks lend to each other. It typically is about 0.10% above Bank Base Rate and that's exactly where it is today. Base rate is 0.5% , six month LIBOR is 0.6%.

This is important for two reasons. Firstly it reflects the story that banks now have enough money to lend to each other and that they consider the risk no higher than it has been historically. Secondly if the six month rate is so low, it indicates that the bank's themselves don't expect an increase in rates anytime soon.

This whole article was inspired by a letter I got today from Mortgage Trust telling me that a fixed rate deal was about to end and encouraging me to sign up for the "very competitive 2 year fixed rate of 3.95%, providing security and comfort". Hmmm!

I checked what would happen if I didn't take up their fantastic offer. It turns out that I will be placed on their variable rate of 3 month LIBOR plus 1.99% margin. Work it out and that comes to 2.59%. That's 1.36% lower than their fixed rate!

So base rate would have to rise from 0.5% to 1.86% to even reach the same repayments as the fixed rate deal, and would in fact have to average 1.86% over the next two years to mean that overall I paid the same.

What this really means is that the base rate would have to rise from 0.5% to 3.72% over the next two years before I am worse off staying on the variable rate.

Decision time. Do I stay on the variable rate or move to a fixed rate of 3.95%?

For me it's an easy decision. Weighing up the data I'm close to 100% convinced that I will be better off staying where I am. I truly don't believe that rates are going to spiral out of control in the next 24 months.

Of course I could be wrong. Ask me in two years time!

Whether you come to the same conclusion is less important than if you take the time and trouble to run the same calculations and make sure that what seems like a simple, good offer from the bank truly is worthwhile. Remember that where banks are concerned you can be pretty sure that when they recommend you switch products, you are mostly better off ignoring their advice!

Should anyone switch to fixed rates right now? Maybe. If you're the type of investor who wears woolly slippers and can't sleep at night unless everything is buttoned down, sure. Or if you are offered a deal, do the maths and are convinced that it's a better alternative. But don't just take what's thrown at you. In the end smart investors will do their own analysis and thinking.

Good investing!

Rod Thomas

Posted in Finance & Money

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