Interest-free mortgages 'set to become reality' » Housing » 24dash.com

Some homeowners could be enjoying an interest-free mortgage next year if interest rates continue to fall steeply, it was disclosed today.

Cheltenham & Gloucester, which is part of Lloyds TSB, offered a two-year tracker mortgage of 1.01% below the Bank of England base rate in July and August 2007.

The deal means that if interest rates fall to 1%, as many economists are predicting, people who took out the loan will not have to pay any interest on their mortgage at all, and will only have to make capital repayments.

With the base rate at 3%, homeowners who took out one of the loans are currently paying interest of just 1.99% - the lowest rate members of the industry can remember.

Anyone who took out the loan on an interest-only basis will have monthly mortgage costs of just £165.83 on a £100,000 loan, while those with a repayment mortgage will be paying £423 a month.

But borrowers had to pay a fee of 2.5%, or £2,500 on a £100,000 mortgage, to take out the deal, and once this is taken into account the so-called pay rate is considerably higher, although still highly competitive, at the equivalent of base rate plus 0.24%.

It is not just borrowers with Cheltenham & Gloucester who could see their mortgage rate fall below 1% if interest rates continue to be cut.

In August 2007 the Co-operative Bank was offering a two-year tracker at 0.61% below base rate.

Nationwide also had one of 0.27% below base rate, although the group will stop reducing the rate if interest rates fall below 3%.

But these deals only run for two years, meaning that borrowers who are currently on them will have to remortgage within the next 12 months on to considerably higher rates, or stay on their lender's standard variable rate.

However, people who took out lifetime tracker mortgages have the rate they pay in relation to base rate fixed for the life of the mortgage.

The Woolwich has previously offered lifetime tracker deals of between 0.17% to 0.29% above base rate, with Cheltenham & Gloucester offering similar rates in the past.

Mortgage commentator Ray Boulger, senior technical manager at John Charcol, said he thought that the Woolwich's offer of 0.19% above base rate for the life of the mortgage was such good value that he took out one of the deals himself.

Mr Boulger advised people on variable rate mortgages who had benefited from recent interest rate cuts to use the money they were saving to repay debt.

He said people should repay the debt on which they were being charged the highest interest rate first, meaning that people who had credit card debts should prioritise using the surplus money to reduce them.

Homeowners without other debt should use the extra money to reduce their mortgage debt, helping them to repay their loan early.

He said most mortgages enabled people to pay off 10% of their outstanding debt or £500 a month early without facing redemption charges, and people who had overpaid in the past were often able to take repayment holidays later down the line.