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.
Whilst there are a number of different mortgages available, there are two main types of mortgage deal to choose from: fixed rate and variable rate mortgages.
Fixed rate mortgages fix your interest rate for an agreed period of time, laying out how much you will have to pay each month over the fixed period. Fixed rates are not affected by the Bank of England and will not change during the agreed period.
Most fixed rate mortgages lock borrowers into the agreement with a high penalty fee if you wish to repay the mortgage before the fixed term expires.
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. Fixed rates can be helpful for certainty and allow you to budget as you know exactly how much you will pay each month.
In contrast, variable mortgages move up and down depending on the movement of the Bank of England base rate. Variable rates fall into three categories, which each have slightly different features: tracker rates, standard variable rates (SVRs) and discount rates.
Tracker mortgages are a form of variable rate mortgage, which differ from standard variable rate mortgages. With a standard variable rate mortgage, 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.
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.
Standard variable rate mortgages generally follow the same principle as a tracker mortgage, but the decision as to what rate to offer ultimately comes down to the mortgage lender.
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.
Discounts on variable rate mortgages are similar to an introductory offer, where 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.
The Bank of England’s base rate has been at record-lows since 2009 and is looking unlikely to rise anytime soon.
Variable rates were traditionally the cheaper of the two options but recently the lowest rates for fixed rate deals have been beating the lowest introductory offers for variable rates.
In either case it's best to try to ignore the markets to a degree and think about your personal circumstances when deciding whether or not to fix your mortgage rate.
In essence fixed, rates tend to work better for people who like the stability of being able to plan how much they’ll spend over the repayment term.
Variable rates are a good choice if you're comfortable with your income and you think rates have got further to fall.
The best type of mortgage will vary depending on your requirements and your circumstances, and there are a number of pros and cons to both fixed and variable mortgage rates.
During 2020, The Bank of England’s base rate has reached record lows and is looking unlikely to rise anytime soon.
The consequence of the low base rate is that recently, the lowest rates for fixed rate deals have been beating the lowest introductory offers for variable rates.
Regardless, it's best to try to ignore the markets to a degree and think about your personal circumstances when deciding whether or not to fix your mortgage rate.
In essence, fixed rates tend to work better for people who like the stability of being able to plan how much they’ll spend over the repayment term. They allow you to budget carefully, knowing what to set aside for the mortgage payments each month.
Variable rates are a good choice if you're comfortable with your income and you think rates have got further to fall. They can also be a sensible option if you need flexibility and want to avoid the penalty charges that fixed rates attract if you repay the loan before the end of the fixed term.
If you decide to choose a fixed term mortgage, think carefully about how long you wish to fix the rate for before you commit to a mortgage deal.
Depending on your financial situation, it may be worth switching from a fixed rate mortgage plan to one with a variable rate, especially when the market leading fixed rates are cheaper than variable rates.
However, be careful to factor in early repayment fees for exiting your current mortgage and any arrangement fees for the new mortgage, which can be costly. Before you decide to switch, work out if the new rate is going to save you more money in the long term than remaining in your current deal.