Which mortgage is right for you? Is it better to fix or not to fix? Read our guide to fixed rate mortgages versus variable rate mortgages
Understanding the key features of a fixed rate mortgage and a variable mortgage can be fairly straightforward, but deciding between the two and picking one that saves you money is much trickier.
When mortgage interest rates are low then it might be worth taking the risk with a variable rate but it’s not always as simple as that.
Mortgages with variable rates – usually come in the form trackers and standard variable mortgages – will tend to follow the Bank of England’s interest base rate (with a little extra added on) but for standard variable rates, each mortgage lender can essentially change the rate to whatever it likes.
However, the likelihood of a mortgage lender setting the variable rate to something astronomically high is going to be limited by competitive pressure, public scrutiny and negative press.
There are also discounted versions of tracker mortgages and standard variable mortgages.
Generally, these mortgages include a discount on the tracker or standard variable rate for a set period of time. For example, you could get a 1% point discount for the first three years of your mortgage repayment plan.
- Tracker mortgages follow the base rate set by the Bank of England, meaning the rate on repayments will move with UK rates, however the mortgage lender will usually charge a percentage point or two more. A discount tracker mortgage will decrease the percentage points off the tracker rate, not the base rate, for a set period.
- Standard variable rate mortgages generally follow the same principle as a tracker mortgage, but that decision ultimately comes down to the mortgage lender. You could get charged higher or even lower than with a tracker mortgage – there is no guarantee. A discount standard variable mortgage will decrease the percentage points off the standard variable rate for a set period.
Fixed rate mortgages simply lay out how much you will have to pay over a fixed period. This rate is not affected by the Bank of England and will not change during the agreed period.
Most likely you’ll be locked into that agreement with a high penalty fee standing in the way.
The inflexibility of a fixed rate mortgage is the price you pay for guaranteeing the rate and allowing you to budget accordingly.
Lenders usually work out the fixed rate you will pay by estimating how interest rates will change over the set period.
Naturally, this estimate will work in the lender’s favour but it can provide a little more peace of mind if you know exactly how much you have to pay.
Fixed versus variable?
The Bank of England’s base rate has been hitting record-lows since 2009 and financial markets are not expecting them to rise until 2016.
While rates are low it may seem better to go for a mortgage with a variable rate, but it’s still a risk, as there is no real guarantee of when interest rates are likely to change.
Fixed rates tend to work better for people who don’t have a back-up option and need the stability of being able to plan how much they’ll spend over the repayment term.
Variable rates can prove to be a money-saving gamble, but it’s still a gamble, and not worth taking if you don’t think you’ll be able to afford repayments should the bank rates suddenly shoot up.
It’s important to plan for such an event and to assess how much you stand to lose should interest rates increase dramatically.
Discounts on variable rate mortgages are similar to an introductory offer, whereby you receive a one or two percent discount from the standard tracker rate or standard variable rate.
This introductory rate usually lasts two to five years, but if you wish to pay off your mortgage or switch it within that time, it’s likely to come at a heavy price by way of a penalty fee.
It’s also important to understand that a big discount doesn’t necessarily mean you’re getting the best deal.
For example, a 2% point discount from a tracker mortgage, which has a base rate plus 3%, is going to leave you with paying the base rate plus 1% for the introductory period, but a smaller discount of 0.5% off a base rate plus 1% is going to give you a better deal.
Ultimately it will come down to what you have to pay, rather than what the discount is.
If you do go for a variable rate mortgage, then familiarise yourself with mortgage collars and mortgage minimum rates, as these could affect how much money you save.
- Mortgage collars set a minimum on how low the rate on your mortgage will go. This fixes the base rate amount, so that even if the bank rate falls below this, you will still be paying extra. For example, you have a tracker mortgage with 2% points above base rate, but with a 2% collar. This means you will always pay at least 4%, even if the base rate drops below 2%.
- Mortgage minimum rate has a similar impact on the rate you pay but is set against the interest rate, rather than the base rate. If your tracker mortgage with 2% points above base rate has a 4% minimum rate, you will pay at least 4%, even if the base rate drops below 2%.
Double check the minimum rate or collar arrangements when agreeing your mortgage to ensure you’re still getting a good deal.
If it’s not in the Key Facts document that comes with your mortgage, then you can complain to the Financial Ombudsman, as the Financial Conduct Authority says that its omission may make the policy invalid.
Switching from a fixed rate mortgage
Is it worth switching from a fixed rate mortgage plan to one with a variable rate?
Consider if it’s worth paying a penalty fee, which is likely to be in the region of £1,000, and if the variable rate is going to save you more money in the long term.
The reality is that you can’t be certain that the variable rate will save you more money long term, but if you’re willing to take the risk then it might be better to do it if you still have a long way to go on your fixed rate plan.