Fixed-rate mortgages explained; A complete guide
What is a Fixed-Rate Mortgage?
A fixed-rate mortgage keeps your interest rate the same for an agreed period, typically between 2 to 5 years, though some options extend to 10 years.
This means your monthly payments won’t change during that time. Once the initial term ends, you can either switch to a new deal with your current lender, remortgage with a different lender, or stay on a reversion rate, which is a variable rate that fluctuates based on market conditions.
How Do Fixed-Rate Mortgages Work?
During the fixed term, your mortgage rate remains stable, regardless of changes in the Bank of England Base Rate.
For instance, if the base rate increases, your fixed mortgage rate stays the same, allowing you to avoid the impact of rising costs.
However, once the fixed period ends, your mortgage will transition to a reversion rate, which can vary and is typically higher than the current base rate.
To avoid higher costs associated with the reversion rate, it’s wise to apply for a new deal or remortgage several months before your fixed term concludes.
Remortgaging is typically possible without the legal or valuation costs involved in a purchase application, especially for residential properties or personally owned buy-to-lets.
UK Fixed-rate mortgage graph
- BOE Rate
- Fixed rate
- Reversion rate
- New deal
The graph above illustrates the behaviour of a fixed-rate mortgage.
Early in the year, the BOE rate increases. The borrower on a fixed rate sees no change in their mortgage rate or payments.
When their deal ends in July, they ‘revert’ to the lender's variable rate, typically much higher than the Bank of England Base Rate.
In October, the customer applying for a new fixed-rate mortgage, gets a deal that is somewhat higher than their previous fixed-rate deal, because the Bank of England Base Rate has increased.
However, it is usually still worth taking a new product each time the current deal ends, as it will normally be lower than the lender's variable rate.
Who Should Consider a Fixed-Rate Mortgage?
A fixed-rate mortgage is ideal when you anticipate that the Bank of England’s base rate will rise significantly.
However, predicting interest rate changes is challenging, as banks typically adjust fixed-rate deals based on expected shifts in the base rate.
Choosing a fixed rate often balances the security of stable payments against the risk of potentially paying more than necessary.
What are the alternatives to Fixed-Rate Mortgages?
If you opt for a variable-rate mortgage, your interest rate and payments may change from month to month. The main types of variable rate products include:
- Tracker Rates: Follow the Bank of England Base Rate exactly, usually at a lower risk.
- Variable Rates: Set by the lender but generally mirror the Bank of England Base Rate.
- Discount Rates: Offer a temporary discount off the lender’s variable rate for a set period, after which they revert to the lender’s standard variable rate.
- Capped Rates: Variable rates with an upper limit, though these have become less common.
- Libor Rates: Based on the London Interbank Lending Rate, these are typically riskier.
Is a Fixed-Rate Mortgage Right for You?
Consider the following questions to determine if a fixed-rate mortgage suits your needs:
- Do you believe interest rates will rise in the coming years?
- Is the cost difference between fixed and variable deals minimal compared to potential rate increases?
- Are you concerned about affording payments if rates rise?
- Would you prefer predictable monthly payments, even if they are slightly higher?
- Do you want to minimize financial risks?
- Are you unlikely to move or make large overpayments during the fixed term?
- Is it unlikely you’ll need significant additional borrowing from your property during this period?
If you answered "yes" to many of these questions, a fixed-rate mortgage might be a good fit.
Keep in mind that many fixed-rate mortgages have high early repayment penalties, which can be a concern if you plan to sell or make large overpayments during the fixed period.
When Are Fixed-Rate Mortgages a Bad Idea?
Fixed-rate mortgages can pose risks, especially due to early repayment penalties. First-time buyers, who often move within a few years, should be cautious. If tied to a lender by a hefty penalty—sometimes 5% or more of the remaining balance—they could face significant costs if they need to switch lenders or properties.
Additionally, if interest rates are likely to drop, a fixed-rate mortgage could result in higher costs compared to variable-rate options.
While variable, discount, and tracker products can sometimes be cheaper over time, they come with the risk of fluctuating payments without an upper limit.
Conclusion
Before committing to a mortgage type, it’s essential to consider your financial situation and future plans.
Seeking advice from an independent mortgage broker can help you make the best choice tailored to your circumstances.
Don’t rush into a decision; understanding your options will help minimize potential risks.