Given that taking out a mortgage is likely one of the largest financial decisions you’ll ever make, it’s important to understand the different options available and be able to have an idea as to which is best suited to you. Of course, applying for a mortgage through a mortgage broker is a great way to receive independent advice as to which product is best suited to your individual financial circumstances not just now but moving forwards as well, however as with everything, it helps if you’ve got an idea as to what is likely to work best for you and have your own understanding as to what the options being presented in front of you mean.
As such, our leading broker, David, has put together a look at the difference between fixed rate mortgages and variable mortgages, looking at which is deemed the best option dependent on individual circumstances. Deciding on the right type of mortgage as a borrower is likely THE biggest decision you’ll need to make so understanding your options helps considerably.
What Is A Fixed Rate Mortgage?
Regardless of what happens to interest rates, with a fixed rate mortgage, you’ll pay the same level of interest each year across the term of the deal. In some instances, mortgage rates will rise and you’ll be paying less than you would be at the current rate offered and in others, rates will drop and you’ll be paying above the current rate. What makes fixed rate mortgages so attractive to home buyers, however, is the fact that payments remain the same each month and from a budgeting and financial forecasting point of view, this is a fantastic plus point.
Of course, you’ll find pros and cons of fixed rate mortgages, as with all types, with the main ones being:
|> Pros||> Cons|
|You know exactly what your mortgage will cost each month – perfect for preparing a monthly budget!||Rates are generally higher than would be the case with a variable mortgage.|
|Interest will remain the same across the incentive period, regardless of how high rates go.||If interests rates go down, you’ll still pay the same fixed cost each month.|
|Rates can be fixed for anything from one to ten years, offering long-term peace of mind.||You’ll usually pay a high penalty for leaving a fixed rate term early.|
If you like the sound of knowing to the penny what your monthly repayments are going to be, it is likely the case that a fixed rate mortgage is a strong contending option for you. Whether you’re a first time buyer trying to balance budgets, a home mover looking to assess your own affordability of a new home or even an investor taking out a buy to let mortgage who wants the reassurance that costs won’t rise over a set period, there’s no doubting that their popularity lies in the fact that the rate is what it says on the tin – fixed.
Top Tip: Spend time working out how long you’d ideally like to fix your mortgage rate for as leaving this can be costly. Always take into account your plans for moving home in the future (especially if remortgaging).
Further questions which we see asked on a regular basis surrounding fixed rate mortgages include:
Why Does The Rate Go Up The Longer The Fixed Term?
When you take out a fixed rate over a longer period of up to ten years, you’ll find the rate is higher than fixing for one or two. This is due to the fact that lenders are taking a greater risk that interest rates could rise over a longer period whilst still having to guarantee your rate if this happens.
Of course, what we still come back to for many is that, despite a higher rate at this stage on some mortgages, the certainty of monthly payments remaining fixed is a far more attractive offering.
What Is An Incentive Period?
As with all mortgages, you’ll take a fixed rate one out over a term of anything up to 25 years or, in some cases, longer. That doesn’t, unfortunately, mean you’re able to fix the rate for the entire term. The period of up to ten years of the fixed rate is known as the incentive period.
What Happens After The Incentive Period Ends?
Don’t panic! You won’t be expected to repay your mortgage in it’s entirety at the end of the incentive period and in most cases, after this you’ll go on to the lenders SVR (standard variable rate). Of course, this likely isn’t the best deal and most will remortgage at the end of an incentive period to ensure they’re paying only the interest rate which they need to.
What Is A Variable Mortgage?
Whereas with a fixed rate mortgage the interest rate and, as a result, your monthly payments remain the same each month across the incentive period, with a variable mortgage, rates and repayments can, and do, go up and down with the primary cause of fluctuations being the economy.
When the economy is booming and growing, interest rates increase to try and discourage spending whilst the opposite happens and rates drop when we experience a downturn.
What many don’t realise, however, that variable mortgages fall into three categories, all of which offer something slightly different to the others:
1. Tracker Mortgages
Tracker mortgages work where the rate track usually the Bank of England’s base rate (but can also track the Libor rate ) and will move in line with it. It’s important to understand that this doesn’t mean the rate is the same as the base rate however they’re a popular option for many, especially in times such as the present where the base rate is low. In addition, many are sold by the fact that only economic factors will move the rate, not commercial decisions by the lender.
As with a fixed rate mortgage, you’ll be tied into a tracker for a set period of time, most commonly for two years, however it’s also possible to take out what is known as a ‘lifetime tracker’ which tracks across the full term of the mortgage.
A word of warning here is to watch out for mortgages labelled as ‘trackers’ by lenders but which include small print which allows them to increase the rate for reasons other than the base rate changing.
2. Standard Variable Rate Mortgages (SVRs)
Every single lender have an SVR (standard variable rate) which they’re free to move up and down as they see fit, however again, these usually roughly follow the Bank of England base rate and sitting anything between 2 and 5 percentage points above. SVR’s can vary significantly between lenders.
In many instances, SVR’s are rarely opted for given the alternatives available and often aren’t available to new customers, however it is this which a mortgage will transfer to at the end of the incentive period on a fixed term, as an example.
In some cases, SVR’s can be cheap, however it’s often a risky decision given that a lender can, in theory, change the rate at any time.
One main benefit which is seen on SVR’s is the ability to repay in full without facing any form of financial penalty, thus making them ideal for those who may only need a mortgage over a short term with the potential to repay early in full.
3. Discount Rate Mortgages
The third variation on variable mortgages, discount rate mortgages, usually see a discount offered against the lender’s SVR, with many lasting between two and three years. Some discount rates, however, are available over the lifetime of a mortgage.
When considering discount rate mortgages, our top tip is to be sure to read and comprehend the marketing material properly. A discount rate could be offered at 2%, however you need to understand whether this means a 2% discount off the SVR or whether the rate payable is 2%.
You may not always get the benefit of base rate changes with a discount rate unless the lender changes their SVR however similarly, a discounted rate can go up if the lender hikes up their rates.
What Is A Capped Deal?
Given that variable mortgages can, and do, go up and down, in many instances, lenders will offer what is known as a capped deal, meaning that there’s an upper ceiling in place which rates can never rise above. This can go some way in reducing the levels of risk associated with variable deals and the uncertainty which many borrowers have surrounding the potential for repayments to spiral should rates suddenly soar.
Capped deals are, however, relatively rare nowadays and even when they are available, caps can be set quite high and the starting rate is often higher than on other deals.
Which Mortgage Should You Choose?
The question of which mortgage should you choose comes up time and time again and it’s important that you understand the core differences between fixed and variable rate deals.
As a general rule, a fixed rate deal is attractive to many given the fact that repayments remain constant but it’s important to understand that this is essentially an insurance policy against rising rates. As such, you’ll often pay a premium for this benefit.
On the other hand, variable rates can be risky and there is always that uncertainty as to how much repayments will be, especially when rates can rise relatively quickly. Of course, when rates from on a variable mortgage, monthly payments will go down.
At the end of the day, few borrowers understand the specific ins and outs of the difference types of mortgage and, as such, it always pays to sit down with a professional mortgage broker, discuss your individual financial circumstances and work out which type will work best for you not just now but moving forwards into the future as well.