Getting out of a fixed rate mortgage is costly but could deliver long term savings, writes Jack Fagan

BORROWERS WHO locked into a high fixed rate mortgage last year should now be reviewing their options because of the sharp fall in interest rates over the past four months. In most cases it will probably pay in the long run to bite the bullet at an early stage and switch out of their current deal even though it will inevitably involve payment of thousands of euro in penalties.

Fixed rates peaked in the summer of 2008 as the credit crunch began to bite and borrowers suddenly realised that mortgages were no longer being handed out like snuff at a wake. Two and three-year fixed rates eventually settled at between 5.5 and 6 per cent.

Customers with variable and tracker mortgages had by then almost experienced death by a thousand cuts – there were no fewer than nine rate increases of a quarter per cent, ending up in July with 4.25 per cent.

After the steady flow of increases over a period of 18 months many borrowers sought refuge in a fixed rate arrangement to allow them to plan their finances. Even more importantly, they feared that credit could become even more expensive.

As we all know credit became quite scarce because of the turmoil in the global banking system over toxic loans and the almost daily dose of bad news about the economy. The Americans and the Brits immediately dropped interest rates in an attempt to reverse economic trends and, in due course, the ECB also reduced rates by half a per cent and followed up with other cuts to bring the basic rate to 2 per cent.

Even with the usual add-on margin taken by the banks and building societies, there is a hell of a difference between the variable rate and the 5.5/6 per cent fixed rate availed of by many borrowers last year. However, there is nothing new in the lending institutions imposing a penalty on those determined to break out of a fixed rate.

Annette Moore of mortgage brokers MMPI in Donnybrook says that the amount payable is calculated differently by every bank and is based on several factors, such as the cost of funds on the interbank market as distinct from the ECB rate when the request is received, and exactly how many months have to run at the fixed rate and the cost of funds at the time of booking into the fixed rate.

MMPI cite two examples where borrowers paid penalties when breaking out of fixed rate mortgages. In the first case, the client agreed a three-year fixed rate of 5.1 per cent in August, 2008, on a home loan of €430,000. The breakout fee agreed two weeks ago was €19,000. In the second example, the borrower negotiated a five-year fixed rate of 5.45 per cent in June, 2008, on a mortgage of €330,000. The breakout penalty, also set two weeks ago, was €22,000.

Before agreeing on penalties such as these, borrowers need to consider carefully the savings that will accrue each month at the new rate as against the cost of the penalty split over the outstanding term of the fixed rate mortgage.

All this is based on the assumption that mortgage rates will remain at the present low level. With the daily dose of economic news getting ever more grim, it’s a fair bet that rates will remain on the floor for the foreseeable future.

And just in case you think you can phone your bank and ask them to put you on a variable rate from next month, the procedure is a little more complicated. Breakout fees must be paid to the bank by cheque before the rate is amended. Some lenders allow their clients to capitalise breakout fees – in other words, they allow the penalty to be added to the balance of the loan. Some of the banks look at this option on a case-by-case basis, depending on the size of the mortgage and the value of the house. Ouch.....

Pedestrians passing the Bank of Ireland on College Green last Saturday may have been surprised by a large red poster announcing “mortgage week: talk to us in College Green today”. Are things so bad that the bankers have to work on Saturdays? Fear not, because the imposing doors were firmly locked, as were the entrance gates. Is the bank really offering mortgages or was this a PR stunt for their neighbours in the Central Bank?