There Aretwo Sides to That 'Win-Win'spin; Capped-Rate Deals May Appear Very Tempting but Will You Really Benefit If Interest Rates Finally Start Tumbling?

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Byline: NEIL SIMPSON

It sounds like the ideal mortgage.

Pick it, and your payments will fall if interest rates go down. But they are guaranteed not to go through the roof even if rates head back up.

A growing band of lenders are currently promising just this kind of 'heads you win, tails you don't lose' opportunity with a new batch of capped-rate mortgages.

With a capped-rate deal you can hope to enjoy the benefit of interest-rate reductions just like other borrowers.

But there is a pre-agreed limit - the cap - on how high your payments can go if the Bank of England orders some painful rate increases.

Abbey, Coventry, Derbyshire, Marsden and National Counties building societies all offer caps and experts are predicting many more lenders will soon join the market as high oil prices make it harder to know which way interest rates are headed.

In the early summer, for example, most experts predicted UK interest rates were about to start a steady decline to shore up the economy. Now there are fears that they may have to rise to stop high petrol costs from pushing inflation above targets.

'Whenever the future for interest rates is uncertain, borrowers look for an each-way bet on their home loan,' says Simon Tyler, of broker Chase de Vere Mortgage Management in London. 'They want something that will work out for them if rates fall but won't be a disaster if rates rise.

'Capped-rate deals appear to offer this, though in our view they have serious drawbacks and are more psychologically comforting than financially worthwhile.' In fact, an analysis of the latest capped-rate offers shows that while they may well shield borrowers from interest rate rises, they are unlikely to offer any benefits from interest-rate cuts.

WHAT'S ON OFFER?

Abbey's latest capped-rate offering is a good example of how the deals work.

The bank is offering a cap set at 4.99 per cent which lasts until November 2010.

The good news is that the rate you pay on this mortgage now is equal to the 4.99 per cent cap. So even if interest rates rise in the next five years, your payments stay the same.

But will your payments fall if interest rates are cut? This is where capped-rate deals can come unstuck. With Abbey, as with most capped-rate lenders, the deal is that you pay whichever is lowest out of the capped rate and the lender's standard variable interest rate - 6.5 per cent in Abbey's case.

If interest rates fall another quarter of a percentage point to 4.25 per cent, the bank's standard rate would be 6.25 per cent, for example, leaving its capped customers paying 4.99 per cent.

Another quarter of a percentage point reduction in wider rates and Abbey's capped-rate customers still don't see any benefits.

In fact, interest rates would need to be cut by more than 1.5 percentage points before capped-rate customers see their payments fall.

WHO SHOULD CAP?

The fact that many capped-rate borrowers are unlikely to see their payments fall might not be so bad if the rate they pay at the start is competitive.

Experts say that Abbey and Marsden's deals are the best, but can still be beaten by alternative loans.

'In many ways, taking out a capped-rate deal is like taking out a fix because your payments are already pitched at the maximum you will pay and are unlikely to fall,' says Tyler. …