Ask the Expert: Should I take a fixed term or variable mortgage?
Our weekly financial FAQ series continues, with Loan.co.uk CEO Paul McGerrigan answering another question about consumer finance.
The aim of the series is to educate consumers, allowing them to make informed choices on their spending decisions, with a different question being answered each week.
Q: Should I take a fixed term or variable mortgage?
A: Deciding between a fixed rate and variable mortgage is not an easy decision – it’s all down to what is best for each person’s circumstances.
With so many options, it’s hard to know what’s right for you so let’s have a look at what you have to choose from.
Fixed Rate Mortgages
A fixed rate provides certainty: you’ll know exactly how much you’ll pay back each month. Just like the name suggests, you’ll pay a fixed rate for the agreed period of time with your mortgage provider, be it two years, five years, ten years or another length of time.
This means your payments won't go up over the term of the fixed period, no matter how high rates go…but it also means that payments won’t go down, and if you want to get out of the deal early, you will usually have to pay a penalty fee.
The other consideration is that the fixed rate will generally be higher overall than other variable mortgages, especially if you take out the fixed rate for a longer period of time (say, ten years compared to five). This is because the lender takes a greater share of the risk of interest rates increasing, whilst having to guarantee your rate.
So in summary if you like the certainty of knowing your payment, that it is affordable and that it wont change then a fixed rate can be for you.
You may ask what happens when your fixed rate period comes to an end? At this point you will generally be put on the lender’s standard variable rate (SVR), which the mortgage lender can change whenever they like. Once out of the fixed period you do not have to pay any penalty fees if you choose to remortgage to another lender at this point and many people move straight into another fixed rate.
Variable or Adjustable Rate Mortgages
The other common mortgage deals are variable mortgages. If you have more of an appetite for risk and want to try to get the lowest rate available at the time then a variable rate could be for you. As the name suggests, the mortgage rate will move up and down, mainly due to changes in the UK economy but also due to decisions made by the individual lender in the case of mortgages linked to their standard variable rates.
There are three types of variable rates: trackers rates, discount rate and SVR mortgages.
The tracker rate is most common type of variable mortgage and ‘tracks’ the Bank of England base rate directly (e.g. if the rate is 1% above base rate it would be 0.5% + 1% = 1.5% - if base rate increases to 1% the mortgage rate would increase to 2% 1% + 1%) A tracker mortgage will only change when the Bank of England changes the UK base rate. . With this type of mortgage you are generally betting that the base rate will not increase in the near future or if it does that the combined rate will still be lower that you would pay in a fixed rate or discount mortgage.
While this has not happened for 6 years it has been a long time at historic lows and can only go upwards – the big question is when this will happen! If you choose to change lender during the tracker period you will generally pay a penalty fee.
A discount rate offers a discount from the Standard Variable Rate of the lender. The discount term lasts for a set number of years typically 2 or 3. Like a fixed rate mortgage there will be penalty fees to be paid if you remortgage to another lender during the pre-agreed discount period
While both of these can be useful and provide a cheaper rates in the short term there is still a high level of uncertainty. As such, it’s important to make sure that you don’t just focus on the discount but what you might pay overall if rates increase.
In summary, it depends on how secure you feel and how happy you are with risk. If you’d rather pay the same amount each month, even though it may work out to be a higher amount overall, stick to the fixed rate. If you want to get the lowest possible rate and take the hope that rates don’t rise or only rise by a small amount in the coming months and years then one of the variable options may be better for you. Any qualified, competent mortgage adviser or IFA will be able to help you match the best product and lender for your circumstances.