Insuring against rate rises

8:52am Tuesday 15th July 2008

ALTHOUGH interest rates usually fall when recession looms, there is no guarantee of that this time. If UK rates rise from here, homebuyers lacking the protection of a long-term fixed rate mortgage could be squeezed.

This fear of "what lies ahead" in the housing market will boost the appeal of a personal finance product launched earlier this month.

Interest rate insurance is pioneered by MarketGuard, a new company belonging to the Association of British Insurers (ABI) and approved by the Financial Services Authority (FSA).

Its policies will pay out when mortgage rates exceed a level specified when they are taken out.

"We are overwhelmed by the early response - from lenders, housebuilders, financial advisors and mortgage brokers," said Market- Guard chief executive Chris Taylor.

"We have established a strong demand for the product, which will sell through financial advisors and brokers in a few weeks' time."

It can also be purchased online from MarketGuard, although the insurer is neither regulated or authorised to offer advice before purchase.

Mr Taylor said MarketGuard became possible because his team found a way of offsetting risk by using money market instruments.

The rules were amended in the last Budget to clear the way for a scheme intended to bring more certainty to households in uncertain times.

MarketGuard enables borrowers who are not on fixed rate deals to ensure monthly mortgage repayments cannot increase above a prescribed figure if rates rise.

"Our research shows that even the slightest increase in Bank of England base rate could tip people over the edge," said Mr Taylor.

"Our product can bring some stability to millions of borrowers either on variable rate mortgages, or nearing the end of fixed rate deals with little hope of getting a new fix because of tightened lending criteria or the prohibitive cost of remortgaging."

MarketGuard allows borrowers to choose their preferred insured rate at which their policy starts paying out.

This can be between one per cent and 2.5 per cent above the Bank of England base rate at the time of taking out the policy and the policyholder's mortgage rate.

When both rates rise by more than this specified amount, the insurance pays out.

It pays out for a total period of two years - but after the first 12 months, policyholders can fix cover for a further 12 months. It means cover is available on most MarketGuard policies for between 12 and 24 months.

A borrower owing £100,000 with 20 years of repayments to go could insure against a rate rise exceeding one per cent for £39 per month on a repayment mortgage and £53 (interest- only).

With 25 years of repayments ahead, the cost is £42 and £53 respectively.

Premiums in all cases must be paid upfront.

But the first one per cent of any rise in rates, after a policy is purchased, must be fully absorbed by borrowers.

Ray Boulger, senior technical manager at mortgage broker John Charcol, has mixed views about MarketGuard.

"The concept is good, and it is good to see innovation, especially in this market," he said.

However, at the present level of premiums, he questioned whether MarketGuard was good value for money.

"As figures currently stand, it adds about 0.64 per cent to the mortgage rate for borrowers who buy insurance against rates rising in excess of one per cent," he said.

"In fact, rates would have to rise by more than 1.50 per cent to put you in profit from this policy - by recouping a total payout exceeding the total paid in premiums.

"That means the bank base rate will have to average at least 6.75 per cent for the next two years - against the current level of five per cent - for an insurance payout to cover the cost of premiums over that time.

"Even among the gloomiest forecasters, few think things will get as bad as that."

Mr Boulger thinks interest rate insurance could have a future, particularly as lenders make it more difficult for many borrowers to get a fixed rate deal.

But he said: "The problem with insuring now is that the premium invariably factors in the increase which the market still expects. If the economy goes into freefall, that actually looks less likely to happen."