Fixed-rate mortgages explained; A complete guide
Fixed-rate mortgages explained; A simple definition
Simply put a fixed mortgage does not change at all in rate during the initial deal period hence the term fixed.
This means the payments will stay the same until the fixed period ends.
Fixed deals are usually for 2, 3, 4 or 5 years although some longer deals like 10 years may be available.
When the initial deal ends you can switch to a new deal with your current lender or remortgage to a new lender, or simply stay on the rate after the fixed deal called your reversion rate.
Every other type of product is a form of variable rate meaning they can change at any time following various other rates like the lenders standard variable or the Bank of England base rate.
When the mortgage rate changes the payments alter. You can see more in the graph below
UK Fixed-rate mortgages graph
Fixed mortgage products; How they work
In the chart above we see the behaviour of a fixed rate compared to the Bank of England Base Rate (BOE Rate) and other deals like trackers which follow the BOE of rate.
During the fixed period the fixed-rate mortgage stays at the same rate regardless of what happens to the BOE rate.
The BOE rate increases early in the year but the customer on a fixed mortgage sees no effect to their deal. This means the payments won't change and will only vary if you alter them or get into arrears.
Once the fixed-rate period ends in August the rate goes onto what is known as a "reversion rate" illustrated above by the dashed line, usually a form of variable rate the lender can change at any time.
This will usually be higher than the BOE rate is at that time like in the graph. Once on the reversion rate, your payments would alter as the rate changed.
Usually, you would apply for a new deal or a remortgage beforehand so that you don't spend much time on the reversion rate.
If you didn't though you would tend to find that the reversion rate will largely follow the BOE rate to a fair extent.
Bear in mind that remortgaging doesn't usually include the same valuation and legal costs you pay when you buy the house.
You can see that whenever you take a new deal there's a good chance it will be better than the lender's reversion rate at that time, but also higher than the current BOE Rate
Fixed-rate mortgage products; Who should take a fixed rate?
Ideally, you should take a fixed mortgage when the Bank of England base rate is going to rise above the fixed rate by a big enough margin to make the fixed deal better value for money.
Unfortunately, it's difficult to predict interest rate changes and the fixed deals will already be priced by banks to reflect expected changes to the Bank of England rate
So largely it comes down to a compromise between the security of knowing what your payments will be, avoiding the unpredictability of rate increases versus the risk of paying more than you need to.
The fixed-rate questionnaire
So if you're considering a fixed-rate mortgage then the more of the following questions you would answer yes to, the more likely they are appropriate for you.
- Do you think interest rates over the next few years are going to increase?
- Is the difference in cost between the best fixed deals you can get and the best variable types of deal small in comparison to how much you think rates might increase?
- Are you worried about increases making it difficult to afford your payments?
- Would you prefer to pay a bit more for the certainty of your monthly payments?
- Would you say you prefer to keep risks minimal?
- Is it unlikely you would be looking to move property during the fixed period, or make very large overpayments (for example significantly more than 10% of the balance in a single year)?
- Is it unlikely you would be looking to raise large amounts of additional borrowing from the property for any reason during the fixed period?
The last two points are very important, most fixed mortgages have higher early repayment penalties and so may be less suitable for someone who is intending to sell their property in the short term, or perhaps expecting to make very large overpayments as it may trigger the need to pay a large penalty (typically 2 to 5% of the balance being repaid) where some types of mortgage may have little or no penalty at all.
Raising additional borrowing from the property could also be at a much higher interest rate (these are usually called further advance rates) or the lender may be unable to offer what you need forcing you to pay the penalty to change lender.
So someone doing something like renovating a house using large sums of their savings, but then intending to raise the money back out of the property once works are complete a few months later may find it better to consider other deals
As always though, it makes sense to get advice which is why the financial conduct authority has banned the sale of mortgages without offering advice.
An independent mortgage broker like ourselves can discuss your circumstances with you and give tailored recommendations to suit your intentions and ensure you minimise the risk of choosing the wrong type of deal - so don't set your mind on something until you have taken advice!
When are fixed mortgages a bad idea?
By far the biggest risk with fixed-rate mortgages are higher early repayment penalties.
As per the notes above anyone likely to need to move house, make large overpayments (perhaps above 10% of the balance in a single year), raise additional money from the property or anyone who is going to sell their property or pay the mortgage off entirely should pay significant attention to the risks of high early repayment penalties.
5 year fixed mortgages are very often taken by first time buyers, who may be one of the most likely groups of customers to want to move home within that time.
If then tied to that lender by a redemption penalty that could be 5% of the balance (or even more than that on some long term 5 year plus deals) they could be caught by a huge penalty if that lender is not able to port the mortgage to the new property on the terms they need.
like not being able to lend enough money for example, or accepting the new property type.
Fixed-rate mortgages are also generally a bad idea when the likelihood of big decreases in interest rates is high. You might need to be a DIY economist to be able to predict this though.
For the last five years or more most industry pundits have predicted interest rate increases within a year or two, and yet the only change has been down slightly.
For anyone interested in saving money though, who could afford increases in costs then variable, discount and tracker products will very often end up being cheaper long term than fixed deals.
However, most of them have the risk of having no upper limit on payments at any time.