Which is best, a fixed-rate or variable-rate mortgage?

Which is best, a fixed-rate or variable-rate mortgage?

For anyone looking to buy a house or to remortgage their current home, the amount of choice in the market can sometimes be a little overwhelming as it’s such a big commitment and could be your largest monthly outgoing. A fixed-rate mortgage gives you certainty and protection against rising interest rates, however, trackers can also be appealing when interest rates are low. We asked our team of experienced mortgage advisers in Tunbridge Wells for their thoughts on the different types of mortgages available.

What is a mortgage?

Let’s start with the basics. A mortgage is a type of loan offered by a bank or building society that can only be used to purchase a property. The property is typically used as security and the loan attracts interest.

Interestingly, the word mortgage stems from the 14th-century French phrase ‘mort gaige’ which, amusingly, translates as “dead pledge”! Essentially, the agreement will die when the debt is paid in full or, if payment should fail, the property is repossessed by the lender.

Those that wish to purchase a property and are unable to buy it outright in cash, will typically raise a cash deposit (a proportion of the value of the house) and borrow money from a lender (in the form of a mortgage) to cover the rest of a purchase. For example, if the house is £350,000, a 10% deposit would be £35,000 and the mortgage would be £315,000.

Given the size of mortgages, the repayments are often spread out over a long period of time to make the repayments as manageable as possible, which could be anything from five to thirty years. Using our previous example, a mortgage of £315,000 would result in a repayment (before interest) of £5,250 each month over 5 years (60 months), £2,625 each month over 10 years (120 months), £,1312.50 over 20 years (240 months) and £875 each month over 30 years (360 months). This repayment period is known as the ‘term’ and the longer the term, the lower the monthly repayment will be.

What is mortgage interest?

Obviously, lenders aren’t in the mortgage business to help people out by offering interest-free loans; it costs money to administer a mortgage, some mortgages won’t be repaid and because the banks are committing cash, they also want to turn a profit. For these reasons, every mortgage deal will have an interest rate attached to it.

Interest on mortgages is either fixed-rate or variable-rate. A fixed-rate mortgage means that your monthly mortgage repayment won’t change, whereas a variable interest rate mortgage means that your monthly mortgage repayment could fluctuate as the lender sees fit and is not necessarily linked to the Bank of England’s interest rates.

The way that mortgage interest rates are offered varies, but in general, you will find that lenders typically offer an initial special rate for a period of time (often between 2 and 5 years) before you then switch to their standard-variable rate (the SVR). Note that the SVR will often be higher than the introductory rates offered by lenders, and it’s for this reason that people will seek to remortgage with other lenders once their initial period has lapsed in order to find a reduced monthly repayment and better value.

What is a fixed-rate mortgage?

If you are pushing your budget or perhaps you are someone who likes the security of knowing that your repayments won't alter, a fixed-rated deal could be for you. However, there is a cost to this peace of mind as the interest rates on fixed-rate mortgage deals are often higher than they are for the introductory rates on variable-rate mortgages. You may also find that the upfront fees can be higher on fixed-rate mortgages.

In terms of time-frame, two-year fixed rates are the most popular with British homeowners, but as household budgets are squeezed, an increasing number of borrowers are looking to longer-term, fixed rates of five or even ten years. These longer, fixed-rate periods give homeowners more certainty and over the longer term, means there are fewer mortgaging costs to pay. It’s not all good news though as you will be liable to a substantial penalty if you decide to leave before the fixed rate period has ended.

As a result, if you feel that a fixed-rate mortgage is for you, it’s important to make sure that the loan is ‘portable’, which means it can be carried with you if you decide to move house. Although if you are trading up, it’s worth bearing in mind that any extra additional borrowing will likely have to be with the same lender.

What is a variable-rate mortgage?

Unless a mortgage deal has a fixed rate, it will fall under the heading of a variable rate mortgage. As previously mentioned, those that don’t keep an eye on their mortgage deal will often find themselves on a lender’s standard variable rate (SVR).

What is an SVR mortgage?

SVR mortgage interest rates in theory track the Bank of England’s base rate. However, as lenders are not obliged to pass on any savings or alter their rates within a set period of time, they may end up being a poor choice in the longer term. Equally, borrowers may be frustrated that lenders can reduce their SVR slightly less than any base drop reductions and slightly more than any base rate increases. So what are the alternatives?

What is a tracker mortgage?

A tracker mortgage is a type of variable rate mortgage that actually ‘tracks’ the Bank of England’s base rate. The benefit of a tracker mortgage is that borrowers will see the benefit of any drops in the base rate, however, they will also be faced with a higher monthly repayment if the Bank of England base rate is increased. Interestingly, in previous years some lenders were offering tracker mortgages at the Bank of England base rate minus 0.5 per cent, which meant that over time, as interest rates reduced, their interest on their mortgage reduced to nothing. A great result for the borrower! As a result, lenders have since set tracker mortgages to track above the base rate.

When considering a tracker mortgage, it’s important to consider the early redemption charges so you can remain agile and move to other deals in the event of base rate rises. Some trackers also feature a cap on how high the rate can go, which could insulate you from any sudden increases in the base rate, and some offer a minimum rate, known as a collar. Those that offer both will refer to them as ‘cap and collar’ rate mortgages.

What is a discounted-rate mortgage?

A discounted mortgage is similar to a tracker mortgage, but rather than tracking the Bank of England base rate, they track a lender’s SVR, either at a margin above or below it. As with a tracker mortgage, they can leave borrowers exposed to the danger of rising interest rates. However, the benefit is that rates tend to be more competitive than fixed-rate deals. Given that interest rates are generally still low at the moment, discounted-rate mortgages are rarer than they once were.

Which is best, a fixed-rate or variable-rate mortgage?

When it comes to choosing the right mortgage for you, your first considerations should be affordability and how your mortgage fits into your overall monthly budget. On a fixed-rate mortgage, your monthly payments will be fixed whereas with a variable-rate mortgage, your monthly payment could increase (or decrease). As such, if a mortgage payment only makes up a small proportion of your take-home pay each month, you may be better placed to try and get the best value variable-rate mortgage as any potential increases won’t necessarily have a dramatic impact on you.

What’s important to remember though is that lenders want to maximise their profitability and, in an ideal world, would have all borrowers on their SVR. As such, they hope that once any introductory discounts have ended, borrowers are too lazy to remortgage and end up on the expensive SVR anyway. To help our clients, where we have recommended a fixed or discounted rate, we will make contact before your deal is due to end to make sure we can get the right mortgage for you before you end up on the SVR.

Another thing to bear in mind is that some of the best deals may have terms attached, like an extended fixed rate period that means although you are on a 2-year fixed deal, you can’t switch deals for a further 3 years, which could make it very expensive. Therefore, you should keep an eye on mortgages without extended redemption penalties and with favourable early repayment charges.

One final thing to bear in mind is that switching mortgages can be expensive, as you will face admin charges, valuation fees and possibly exit fees in addition to early redemption charges. As a result, it’s often best to find a good, long term deal and stick with it, however, everyone’s individual circumstances are different.

Conclusion.

Finding the right mortgage can be daunting, but our team of experienced and friendly mortgage advisers are on hand to help you every step of the way. We will work with you to discuss the pros and cons of variable and fixed-rate products and with your budget in mind, find a mortgage that works for you.

What’s next?

If you need help or advice with finding the right mortgage, wherever you are in the UK, you can talk through your options with one of our Mortgage Advisors right here in Tunbridge Wells.

This article offers information about mortgages and should not be taken as personal advice. Think carefully before securing debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage or any other debt secured on it.