What is a fixed rate mortgage?
A fixed rate mortgage offers a period where the interest rate is fixed. This is usually either two, three, five or ten years
During the fixed term, your interest rate (along with your monthly payments) won’t move or fluctuate, regardless of what’s happening externally in the economy. If the Bank of England (BoE) base rate (the rate that sets the level of interest charged by banks and lenders) rises or falls, your interest rate won’t be affected during the fixed term, because it’s just that – fixed.
Fixed rate mortgages can offer a sense of security, as you know exactly what your monthly repayments will be for the fixed term.
As a result, they can make budgeting and financial planning easier, too. However, if you want to switch deals whilst you’re in the middle of your fixed term, then early repayment charges are likely to apply. You would need to check your terms and conditions for further details.
What happens when my fixed rate mortgage ends?
At the end of the fixed term, you’ll be automatically moved onto your lender’s standard variable rate (SVR). This is the rate the lender charges outside of fixed term rates. SVRs tend to be higher than fixed rates, which is why many people choose to remortgage once their current deal ends.
Once you get to this point, you switch providers or stay with your existing provider. Either way, you won’t face early repayment charges when you’re on the SVR.
What is a variable rate mortgage?
With a variable rate mortgage, the interest you pay each month fluctuates, which means your mortgage payments can go up and down.
Some months you may end up paying more than you expect, and others you may end up paying less – it can work both ways.
There’s no way to guarantee how much interest you’ll pay month on month because it depends on external factors. Because of this, variable rate mortgages are sometimes considered riskier than fixed rate mortgages. They can also make it harder to budget.
However, the benefit is, if interest rates go down, your payments will also go down. Plus, you can switch deals or pay off your balance at any time – without facing early repayment charges.
What are the main types of variable rate mortgage?
There are two main types of variable rate mortgage:
- standard variable rate mortgages
- tracker mortgages
1. Standard variable rate mortgage
This is the rate you will automatically revert to when your existing mortgage deal ends unless you remortgage. The interest on a standard variable rate mortgage is set by the lender.
While rates tend to fluctuate in line with the Bank of England base rate, lenders are free to increase or decrease them whenever they like, by as much or as little as they like. As such, interest rates on SVRs are not very competitive and are usually higher than fixed rate mortgages or tracker mortgages.
2. Tracker mortgage
A tracker mortgage follows the base rate, but the interest rate you pay will be a certain percentage above or below it.
For example, your interest rate may be 1% above the base rate, so if the base rate increases by 0.5%, your rate will increase by 1.5%. This is because your rate tracks the activity but adds an agreed percentage on top.
Read on for more about tracker mortgages and other types of mortgages.
Fixed vs variable mortgage
Choosing between a fixed and variable mortgage can be a daunting decision, so it’s important to know the key differences between them, to find what’s best for you. So, to help you with your decision making, here’s a quick run through of the main pros and cons.
Pros and cons of a fixed rate mortgage
A fixed rate mortgage tends to be more suitable for those seeking certainty when it comes to their monthly repayments. As the interest rate is fixed, you know exactly how much you’ll be paying each month for the duration of the fixed term. If that’s important to you, then getting a fixed rate mortgage may be a good option.
While fixed rate mortgages offer this kind of security, they do lack flexibility.
If your circumstances change for any reason, and you need to get out of your mortgage, you’ll face early repayment charges if you switch during the fixed term.
These charges can be up to 10% of the remaining amount that you owe on the mortgage, making it expensive to switch.
Pros of a fixed rate mortgage
- your monthly payment will stay the same, even if external interest rates increase
- easier for budgeting and financial planning
- can fix the interest rate from two to ten years, which can help with long-term planning
- can be cheap if you take out the fixed rate when interest rates are low
Cons of a fixed rate mortgage
- you’ll face early repayment charges if you switch or move home before the fixed term ends
- your interest rate won’t go down if the base rate decreases
- you’ll be put onto your lender’s SVR at the end of the fixed term, which will be more expensive
- the longer the fixed term you choose (i.e. up to ten years), the higher the interest rate will be
Pros and cons of a variable mortgage
A variable rate mortgage may seem a riskier option because the interest rate has the potential to fluctuate – but just because it can, doesn’t mean it will. The fluctuations may be minimal and have the potential to work in your favour. If the interest rates drop, then a variable rate mortgage could work out cheaper in the long-term.
Variable mortgages tend to be more suitable for those who feel confident they can weather the ups and downs of the economy.
As they don’t have early repayment charges, they also lend themselves to those who may want to move or overpay soon.
Pros of a variable mortgage
- more flexible
- no early repayment charges
- tend to have lower arrangement fees than other types of mortgages
- have the potential to work out cheaper in the long run if the interest rates work in your favour
Cons of a variable mortgage
- if you’re on the SVR, the lender has the power to change interest rates whenever they like
- they can be more expensive than fixed rate mortgages
- your payments can go up (as well as down)
- more difficult to budget, as you can’t predict changes to external interest rates
Should I get a 5-year fixed mortgage?
If you’ve decided that a fixed rate mortgage is the option for you, then the next step is to decide how long you want to fix your interest for. At first glance it may seem like an obvious answer – surely fixing it for longer makes sense as it offers long-term security? However, it isn’t necessarily that straightforward.
Here are some of the advantages and disadvantages of getting a long-term five-year fixed rate mortgage.
Advantages of a 5-year fixed mortgage
While five-year fixed rate mortgages tend to have a higher interest rate than a two or three-year fixed mortgage, that difference tends to be minimal. This means that you can have long-term security for not much more money.
Plus, you’re protected from interest rate increases for the next five years. And knowing exactly what your mortgage outgoings are going to be for the next five years allows you to make accurate long-term financial plans.
Disadvantages of a 5-year fixed mortgage
If your circumstances change during the five year period and you need to move or remortgage, you’ll face early repayment charges, which can be expensive. Also, locking yourself into an interest rate for five years may mean you may miss out on better deals at around the two-year mark (if your loan-to-value has decreased in that time).
If you get a fixed rate when interest rates are high, then you’ll be stuck with this for five years, even if interest rates drop just a year later, for example.
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Mortgages are secured against your property. This means your home may be at risk if you fall behind with your mortgage repayments.
Note, the more you borrow and the longer your mortgage term, the more interest you'll pay in total.
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