A fixed-rate loan still makes sense

Are fixed-rate home loans the most sensible option for new borrowers and those seeking a remortgage? Or should they opt for discounted mortgages, where the cost of the loan is kept at a set percentage below the prevailing variable rate?

I am drawn into the debate by a claim earlier this week that fixing a mortgagemay not be the best choice. The argument is that variable interest rates - the bog-standard mortgage repayment mechanism, have almost reached their peak with Abbey National and Northern Rock's decision this week to raise the cost of their loans to 8.7 per cent. If rates are going to come down again, a fixed mortgage is likely to prove uncompetitive within a short space of time.

It seems to me that there are two key considerations that have driven the long-term rate deals now available. The first is the money market's perception that by handing over control of base rates to the Bank of England, the Chancellor of the Exchequer has increased long-term monetary stability. Secondly, the Government's hope to join the European monetary union (EMU) in due course raises the possibility of future interest rate falls.

What has been the market's reaction to these two possibilities? Actually, long-term interest rates have already come down. From a peak of almost 8.5 per cent just nine months ago, it is now possible to find a five-year fixed-rate mortgage from Northern Rock at 5.99 per cent (plus compulsory insurances) or 6.25 per cent from Alliance & Leicester, with no insurance requirements.

But if base rates were to drop next year, as many expect, wouldn't that mean even cheaper fixed rates? Perhaps, but if the markets have already factored in this potential movement, not by vast amounts - perhaps 0.5 per cent or so.

And what of EMU? Research by Chase de Vere, a London mortgage broker, shows that even if the UK joins (not until 2002, mind) mortgage costs in Europe do not suggest that convergence of base rates will mean a reduction in home loan rates.

The margin between retail base rates and mortgage rates is already lowest in the UK and Ireland, at about 0.7 per cent. Elsewhere in Europe it is much wider.

What then of discounted rates? One of the better five-year discounts available to first-time buyers is 1.25 per cent from Nationwide, which now charges 8.1 per cent, plus compulsory insurances usually deemed to add 0.25 per cent to the cost of a loan. Borrowers would effectively be paying 7.1 per cent.

For borrowers to benefit from this discount over and above that offered by the A&L fix, rates would have to come down by 0.8 per cent next week and stay below 7.5 per cent for five years.

Is that likely? I don't know. What I do know is that warning people against fixing a mortgage rate, particularly when they need to control their outgoings several years in advance, is very risky advice.