Question: From its peak at the end of 2007, house prices in London have dropped around 15% until now. Believing that this downward trend is about to be reversed, Tom Herbert, a single 26 year-old trying to get on “the property ladder” has identified a 1-bedroom flat he could buy for £250,000. Tom contacted a number of financial institutions and was offered the following mortgage options:

? repayment fixed rate for 2-years of 2.94%. After that period, the rate reverts to the bank’s standard variable rate, which currently is 5%;

? repayment fixed rate for 5-years of 3.55%. After that period, the rate reverts to the bank’s standard variable rate, which currently is 5%;

? interest only mortgage at 4% for the life of the loan. In this instance, you would be required to create an investment fund, which pays an interest rate of 2.5% to cover the repayment of the mortgage.

Assuming he wants to finish paying the mortgage by the he is 50, please advise Tom on which option he should pursue, including an assessment of whether that advise would change if interest rates went up or down by up to three percentage points.