When you apply for a mortgage, you face an important decision: should you go for a fixed interest rate or explore more flexible options? In this article, we'll break down the pros and cons of fixed-rate mortgages, variable-rate mortgages, and the best time to fix a mortgage.
A fixed-rate mortgage is a home loan with a fixed interest rate for a set period. Most financial institutions offer fixed-rate mortgages in the introductory phase of mortgage loans.
A standard variable mortgage is a home loan whose interest rate is not fixed. The interest rates can change at the lender’s discretion.
A tracker mortgage is a type of variable-rate mortgage where the interest rates are based on the base rate announced by the Bank of England.
Currently, fixed-rate mortgages are more expensive than discounted variable-rate mortgages, and experts expect the interest rates to keep falling. Thus, it is not advisable to fix mortgages on short terms.
Fixed-rate mortgages explained
A fixed-rate deal is a type of mortgage that attracts a specific interest rate. Most mortgage lenders offer fixed-rate deals in the introductory phase of the loans, which lasts between two and ten years.
If you are servicing a fixed-rate mortgage, you'll be paying the same principal amount and interest every month until the product’s fixed period ends. This means that fluctuations in the market do not impact fixed-rate mortgages.
Fixed-rate mortgage terms usually last between 2 and 10 years, with the most common terms being 2,3, and 5 years – but 10-year fixed rates have been introduced to the market increasingly.
What is the incentive period?
During the incentive period, the borrower pays a fixed, low rate. The actual lifespan of the mortgage is longer than the incentive period. Incentive periods vary between lenders, and rates offered during the period also depend on the agreement between the borrower and the lender.
When a fixed deal ends, the interest rates charged on the loans usually change as the lender reverts to the lender’s standard variable rate. Standard variable rates are typically higher, which bumps up monthly mortgage repayments. It is advisable for borrowers to remortgage sooner to avoid paying higher interest rates.
- Easy budgeting: One of the defining features of fixed-rate mortgages is the fixed nature of monthly payments for a specific period. For the period, the borrowers are certain of monthly payments, making it easy for them to budget the loan repayment for that period.
- Capitalise on low interest rates: If the rates are low at the time a mortgage deal is fixed, it will allow borrowers to lock in a cheaper rate for a period of time, which will reduce the overall cost of the mortgage.
- Rates don’t depend on the base rate: Typically, mortgage loans are based on the base rate stipulated by the Bank of England. Instalment rates are solely based on the initial agreement between the borrower and the lender.
- Miss out on benefits of rate drop: In instances where rates drop following the base rate, borrowers servicing fixed-rate mortgages miss out on low repayment rates because their rates are predetermined.
- Exit fees: Borrowers are likely to pay high exit fees, known as the early repayment charge, to get out of their deal when switching to a fixed-rate mortgage, which can go as high as 5% of the total amount borrowed.
- Limited access: Long-term fixed-rate mortgages are complex for borrowers to qualify for. Lenders subject borrowers to stringent scrutiny before they access the product. Only borrowers with a solid financial background qualify for long-term fixed-rate mortgages.
What are the alternatives to fixed-rate mortgages?
Most financial institutions in the UK provide various mortgage options to provide customers with alternatives. The most common alternatives to fixed-rate mortgages are standard variable-rate mortgages (SVR) and tracker mortgages.
Standard variable-rate mortgages
Standard variable-rate mortgages don’t offer fixed interest rates. Instead, lenders occasionally adjust the interest rate per prevailing market interests.
When servicing standard variable-rate mortgages, you usually pay varying monthly instalments. Usually, borrowers whose existing fixed rate, tracker, or discount mortgage ends are moved to standard variable-rate mortgages.
Interest rates on SVRs are usually higher than other options. If you don’t remortgage in time, you may end up paying heftier monthly interest.
How does it work?
Lenders determine their own standard variable rates. Even though these rates may be anchored on the base rate set by the Bank of England, lenders are not obligated to follow the base rate strictly. If the base rate increases by 1%, for example, the lender may decide not to change the variable rate, increase the rate by 1%, lower, or more.
The introductory phase of a mortgage usually levies a fixed rate, after which borrowers switch to the standard variable rate. For example, for a 15-year mortgage, the first five years may be fixed rate, and the remaining 10 years charged at a variable rate. However, lenders allow borrowers to remortgage once the fixed-rate phase elapses. The duration of standard variable rate mortgages depends on the agreement between the lender and borrower.
A lender’s standard variable rate is usually more expensive than the best mortgage deals on the market – so it’s wise not to sit on it for too long. If you don’t switch to a tracker or fixed-rate soon, you may end up paying “procrastination penalty” worth hundreds of pounds.
- Rates may lower: If the interest in the mortgage market goes down, the lender may also lower the rates hence lower monthly repayments.
- Lower initial payments: Standard variable rate mortgages may have lower arrangement fees than fixed-rate or tracker deals.
- Price fluctuations: The standard variable rate may fluctuate, making it difficult for the borrower to budget monthly instalments.
- The loan may become unsustainable: The standard variable rate may increase so much that the borrower struggles with the repayments.
Tracker mortgages
A tracker mortgage is a type of variable rate mortgage where the interest rates are benchmarked on BoE’s base rate – though they don’t strictly match the base rate. In most cases, lenders set their interest rates slightly above the base rate (2.75% lender rate when the base rate is 2%, for example).
How does it work?
Tracker mortgages are offered on full term or in a hybrid model. If you opt for a lifetime tracker, you will pay interest anchored on the base rate throughout the term. In a hybrid model, tracker mortgages may be offered in the introductory phase, which lasts between one and five years.
The lender reverts to the standard variable rate model when the introductory phase elapses. You may opt to remortgage the loan when the tracker mortgage phase ends.
Some banks may put up their tracker rates even when the base rate does not rise. Some may even have a “collar” that stops the rate offered in the mortgage from falling too low if the base rate falls below a certain minimum.
- Potential for lower rates: If the base rate offered by the Bank of England drops, the interest rates also drop, reducing repayments.
- Flexibility to switch: Some lenders allow borrowers to switch to fixed-rate mortgages when the interest rates increase.
- Switching incentives: Introductory rates can be more affordable than other options.
- Potential for rate increases: If the base rate rises, the interest rates increase, hence higher repayments.
- Trackers may not always "track" the base rate: Collar rates may prevent interest rates from falling even if the base rates fall to record lows.
- Fluctuating rates: Because of interest rate fluctuations, borrowers may not be able to accurately budget for monthly mortgage repayments.
Why fix a mortgage rate?
Fixing a mortgage rate is the process of switching from an SVR mortgage to a fixed-rate deal. Borrowers who fix their mortgages are usually motivated by the predictability of fixed-rate loans, and the peace of mind they provide.
However, if the rates decline after fixing the rate, the borrower misses out on lower interest rates. Switching to a fixed-rate deal also attracts high exit fees, which are charged to get out of your existing deal. As we said before, it can be as much as 5% of your mortgage.
Factors to consider when fixing a mortgage
Interest rate projections
It is vital to consider the interest rate movements. If the interest rates are projected to rise, then it may be a good idea to lock into a rate. However, if the rates are predicted to fall, fixing the rate prevents borrowers from benefiting from low-interest rates. In such cases, sticking to a tracker mortgage is advisable.
The flexibility of a fixed-rate mortgage product
Some mortgages are “portable”, meaning that you can continue with your current deal if you move houses – but if your circumstances changed since they took it out, you may struggle. This is especially important for those who fixed their mortgages for long periods, 10 years for example.
Time
Fixed-rate mortgages are commonly offered on terms ranging between 2 and 15 years. Borrowers need to consider terms that suit their need for certainty. For borrowers who don’t intend to live in the property for long, it is advisable to fix their mortgages in the short term.
Whether you should go for a variable or fixed rate comes down to how much you want to bet on base rates rising or falling. If the interest rates are projected to rise, then it is the best time to fix the mortgage. Conversely, if the rates are projected to fall, it is clever not to lock into a fixed rate. Unfortunately, there's no way of knowing which direction the rate will go to. While there's an element of taking risks when deciding whether to fix your mortgage, you should also consider getting a mortgage review by a professional to make better-informed decisions.
