Choosing the right mortgage can be complicated. Is a variable or fixed mortgage best for you? How much do they cost and can the cost change over time? Understanding the key features of each type of mortgage and which one is most likely to save you money can be tricky. Our guide looks at variable vs fixed-rate mortgages and how to decide which one is right for your circumstances.
Whilst there are a number of different mortgages available, there are two main types of deal to choose from, fixed-rate mortgages and variable rate mortgages. There are then three types of variable rate mortgage:
Although there are three types of variable rate mortgage and only one type of fixed-rate mortgage, there is a common difference between fixed-rate and all variable rate mortgages.
fixed-rate mortgages fix your interest rate for an agreed period of time. They are not affected by the Bank of England, so the interest rate will not change throughout the duration of the deal. Variable rate mortgages, on the other hand, can change at any time, including during their initial periods.
There are some other key differences between fixed and variable rate mortgages, however, they are dependent on the type of variable rate mortgage you choose. The table below explains this in greater detail to help you to better understand the benefits of variable vs fixed mortgage rates:
|Fixed-rate mortgages||Variable-rate mortgages|
|Tracker-rate||Standard variable rate (SVR)||Discount-rate|
|Can the interest payable change during the deal period?||No||Yes||Yes||Yes|
|When could the rates change?||N/A||When the bank of England (BoE) base rate changes - it will follow any changes exactly. E.g if it goes up 1%, so will your mortgage interest rate||Lenders change their SVR at their own discretion. Changes can be for both economic and/ or commercial reasons||This rate is linked to the SVR so will change if and when that does|
|How are the interest rates set?||Lenders set this rate type by estimating how interest rates will change over the set period||Lenders initially set this at a chosen percentage (usually 1-2%) above the BoE base rate, but it can then only change if the base rate does||Lenders set their own SVR based on a prediction of future market rates, which is why base rate changes won’t necessarily affect it||Lenders set this rate based on a discount of their own SVR rate, so it may be SVR -1.5% for example|
|Are fees payable to leave the deal before the end?||Yes you will usually have to pay early repayment charges (ERCs) to leave a fixed-term deal. These are typically more expensive the longer you have left until the end date||Some, but not all tracker deals tie you in for the initial period, so if you want to leave the deal before the end of that period, you may have ERCs to pay. Check the individual deal||No, you are not tied to an SVR rate and can leave at any time without paying fees||Most discount-rates charge ERCs if you want to leave the deal before the end of the initial period|
|Do they offer the cheapest rates?*||You’ll typically (although not always) pay more for fixed-rates as you’re paying to lock in the certainty that they won’t change||Tracker-rates can be one of the cheaper initial rates available, however, bear in mind that they can change during the initial period||SVR rates are usually the most expensive a lender offers, which is why most people tend to remortgage when they fall onto them||Whilst they are cheaper than the SVR they are based on, discount-rates won’t always be as cheap as tracker-rates|
|Major benefits of this type of rate||Certainty - easy to budget Interest cannot rise for the duration of the deal||More certainty than other variable rates as dictated by external factor (BoE base rate) Your rate could fall if the base rate falls||You are not bound to this rate type so can remortgage at any time You will benefit if the SVR happens to go down||It’s cheaper than the SVR You will benefit if the SVR happens to go down|
|Major negatives of this type of rate||You won’t benefit from falls in interest rates High exit fees||Will rise if the base rate does - this could be substantial if there is no cap Can have high exit fees, depending on the deal Collars could mean that you don’t save as much - look out for deals that have them||Unpredictability - lenders can raise this at any time Usually the most expensive type of rate||If the SVR goes up, so will your interest rate As this rate is based on the SVR it’s also equally unpredictable|
*Please note: access to the cheapest rates will depend on your individual circumstances and individual deal offered, no matter what type of deal you opt for. This is simply to show a comparison of the average initial costs of each rate type
The best type of mortgage for you will vary depending on your requirements and circumstances. When looking at whether to choose a fixed or variable mortgage, there are a number of pros and cons to both.
When you’re looking solely at whether to opt for a fixed-rate or not, it’s best to consider how much certainty you need and how close your mortgage repayments take you to your personal budget.
fixed-rates allow you to budget carefully, so that you know exactly how much to put aside for your mortgage repayments each month for a set amount of time. This means they are probably a sensible choice for those spending a large percentage of their household budget on living costs, that need to ensure they don’t overstretch themselves.
Variable rates of any type are a bit more of a gamble, which means that they are better suited to those with slightly more expendable income. It’s certainly possible that you could save money with a variable rate mortgage if rates fall - but equally, they could rise substantially, so you need to be ready to absorb that extra cost.
If you’re on a standard variable rate, it’s likely to be cheaper to remortgage onto a fixed-rate mortgage in most circumstances, as you won’t have any ERCs to pay. Either way, a fixed-rate mortgage will offer you more certainty vs a variable rate mortgage, as the interest rate cannot increase over the fixed-rate period.
Switching from a tracker or discount variable rate to a fixed-rate will also offer additional certainty, but will need a bit more investigation with regard to costs. tracker-rates are likely to be cheaper than fixed-rates, but they could become more expensive at any time. If there are ERCs to leave your current tracker or discount deal, this could also make remortgaging more expensive.
If you have some cash to play with once you’ve paid all of your household bills, or you’re looking for a bit more flexibility, then variable rates could be the right option for you.
You will need to consider which type of variable rate is most suited to your needs, and weigh up the pros and cons of each before deciding which option is right for you.
It’s also important to check any fees that you would be liable for if you are planning to remortgage before the end of your current deal.
Collars and caps are usually found on tracker mortgages, and while you will benefit from a cap, you should be cautious of rates that have a collar.
Mortgage collars set a minimum of how low the rate on your mortgage will go, regardless of what happens to the indicator it’s following.
For example, a tracker mortgage set at 2% points above the BoE base rate, but with a 1% collar means that even if the base rate fell to zero, you would pay 3% (1% instead of zero + the lender’s 2% above that rate).
Collars should always be displayed clearly and if there is no information about them in the Key Facts document that comes with your mortgage, you can complain to the Financial Ombudsman. The Financial Conduct Authority states that its omission may make the policy invalid.
A cap, on the other hand, is very rare, but if you’re lucky enough to find one, it acts in the opposite way to a collar. So a cap will effectively guarantee that while your rate can rise, it will never rise beyond a designated percentage.
Most do, but it does depend what type of mortgage you have. For example, commercial mortgages, such as buy-to-let mortgages, tend to follow SONIA (Sterling Overnight Index Average).
If you use a sub-prime lender (sometimes known as a bad credit lender) your rate may also be based on SONIA. This is still controlled by the Bank of England, but is a more transaction based rate.