A fixed-rate mortgage is a mortgage product where the fixed interest rate is guaranteed to stay the same for an agreed fixed period. It pretty much does what it says on the tin! Unlike with a variable rate style mortgage, you’ll know exactly how much you’ll need to repay each month during the agreed fixed period.
Before you are enticed by a fixed-rate mortgage, make sure that you are aware of how they work, what happens when they end, and the pros and cons.
Let’s first understand interest rates
It might first be useful to understand how financial institutions set their interest rates for both borrowers and depositors. Interest rates are generally all linked to the prevailing Bank of England ‘base rate’, which is the single most important interest rate in the UK. It determines the rate of interest paid to Commercial Banks that hold money with the Bank of England.
If the Bank of England increases the base rate, then it makes money more expensive to borrow and lenders will similarly increase both their borrowing and deposit interest rates in line with the increase. Likewise, if the Bank of England reduces its base rate, then the money is considered cheaper, reducing interest rates for borrowers as well as for depositors. The Bank of England uses this mechanism to help control inflation in the UK economy.
Each financial institution will set its own base rate or ‘Standard Variable Rate’ (SVR) for mortgage borrowers, based on the Bank of England’s base rate and this will generally move up or down in line with the movement in base rate. This means that if you are a borrower with one of these institutions, then the cost of borrowing will go up or down in line with their SVR. This can make budgeting unpredictable. To help remove this uncertainty, many lenders started offering fixed interest rate deals, where they guaranteed to keep the interest at a fixed rate during an agreed term, regardless of what they, or the Bank of England, did with interest rates.
So, how does a fixed-rate mortgage work?
There are a lot of fixed-rate mortgages available on the market, and 58% of homeowners are on one, making them the most popular option for mortgage borrowers. They offer both security and peace of mind to the borrower that their monthly repayments will be stable and should therefore remain affordable.
Fixed-rate mortgages are generally available as either 1yr, 2yr, 3yr, 5yr, 10yr or 15yr deals. Most commonly though, they are either 2yr or 5yr deals. Generally speaking, the longer your fixed-rate deal lasts, the higher the interest rate will be. For some, the prospect of locking into a fixed rate of interest for as long as five years can be attractive, however, you’ll need to think carefully about whether you want to commit to one deal for that long. If you choose to remortgage or move house during the fixed interest period on your mortgage, you’ll have to break your current fixed deal and this generally triggers an early repayment charge. This charge can often amount to several thousand pounds. Some lenders will allow you to move the mortgage and rate onto a new property. This is known as mortgage porting and will avoid you paying penalties.
During the fixed term, your interest rate and therefore your monthly repayments will be fixed. When this initial period comes to an end, your fixed-rate deal will expire. You’ll still have the same mortgage, but your interest rate will no longer be fixed and instead, you will usually be transferred to the lender’s SVR.
At this point, it is often advisable to take a look at the mortgage market to see what alternative deals are available. You could choose to remain on your lender’s SVR, or perhaps sign up for another fixed-rate deal with your current lender. You may decide to remortgage onto a facility with a different lender who has better deals available.
Fixed-rate vs standard variable rate mortgages
Whether you choose a fixed-rate deal or go with a lender’s SVR will depend upon your personal circumstances and preferences. In the early years of borrowing, you may consider it worth paying a slightly higher interest rate for the certainty of borrowing costs during the initial term whilst your finances settle down. Alternatively, you may simply want the cheapest interest rate available and be prepared to live with a little uncertainty with regards to the future movement of interest rates, so the SVR might be more attractive to you. There is no right or wrong answer to this, so it is entirely down to personal preference.
SVR deals do provide more flexibility, as you are not tied into any deal and therefore have greater freedom to move between different deals and lenders at any time without penalty. They are also generally much more accommodating about allowing lump sum reductions or monthly overpayments if your circumstances allow. Fixed deal arrangements generally only allow a fixed annual allowance to overpay. Anything more than this will incur penalties.
Pros and cons of fixed-rate mortgages
Of course, the big draw of a fixed-rate mortgage is that your interest rate and therefore your repayments stay the same during the agreed period of the deal. Whatever happens in the wider market to affect interest rates generally, your mortgage repayments will not be impacted. And, although uncommon, you can find 15-year maximum fixed-rate deals, meaning you won’t need to think about your mortgage repayments for a long time. Interest rates on long deals like this will, however, be quite a bit higher than those for shorter fixed periods and of course, you are tied in with your lender for the whole of the agreed fixed term.
Some borrowers may look at the general economy and feel that interest rates are likely to go up in the future so think it best to lock into a fixed rate to protect themselves from the expected future interest rate rises.
It can also work against you if rates fall and you are locked into a higher rate, as we saw in 2008 when the financial markets crashed, leaving some borrowers trapped into what then looked like very expensive fixed-rate deals.
It is also important to remember that once you are tied into a fixed-rate mortgage deal, you’ll generally be faced with early repayment charges if you decide to move house or if you want to remortgage. If you then factor in arrangement fees, valuation, and solicitor’s fees, then either option can become really quite expensive. So before opting for a fixed interest deal, be confident that you are settled in your home and won’t be looking to move in the foreseeable future – at least for the term of the deal – and that the deal you are signing up to does exactly what you want it to do.
You may also find it difficult to make overpayments on your mortgage if you are on a fixed-rate deal. Most mortgage lenders impose restrictions limiting overpayments during any initial introductory fixed, tracker, or discount rate periods. If you do expect to be in a position where you can make lump sum reductions or regular overpayments, then you’ll generally find this much easier on a variable-rate mortgage.
Many people try and take out fixed-rate mortgages with the intention of staying in the deal until the fixed period ends, and then perhaps remortgaging to another lender in order to avoid being placed on their current lender’s SVR. To discourage people from doing this, some lenders have begun to introduce clauses into their loan agreements whereby you are compelled to stay with them for a certain ‘tie-in’ period after the fixed-term has ended. Again, this is something to be aware of before you commit to a fixed-rate deal.
When taking out a mortgage or switching deals, enlisting the help of a professional mortgage advisor and broker, such as us here at Mortgage Light, can make navigating fixed-rate and standard variable rate mortgages plain and simple. There’s no need to get bogged down in the jargon. Our friendly experts will guide you through each step of the way, explaining how these different types of mortgages work, and which your circumstances are best suited to.