While buyers may be impatient to secure their homes, it is worth taking the time to consider the long-term impact that your mortgage type will have on your future finances.
Knowing the difference between variable and fixed rate mortgages is an essential part of choosing the best mortgage for you. If you’re unsure about these mortgage types when comparing products directly with lenders or with your mortgage broker, read on to find out more about the options available before you jump in to a decision.
What is a fixed rate mortgage?
A fixed rate mortgage is a way for a buyer to fix a specific rate of interest over the initial period. This is typically between two and five years depending on the lender and the deals available on the market.
As a buyer, this means that the amount you repay each month will remain the same during the duration of the fixed rate period. When the term comes to an end, you will then be switched to a variable rate as set by your lender (unless you take on a new mortgage deal with your existing lender or a new one).
Benefits of a fixed rate mortgage
A fixed rate mortgage is a great option for buyers who are on a tight monthly budget and need the security of knowing their mortgage repayments will stay the same. For young families, this arrangement can be useful while working towards a higher salary or paying off debts.
A fixed rate mortgage is an option for many types of borrowers. From those who are on a tight budget and cannot afford for repayments to rise, to those that simply want stability in their monthly commitments.
This can be an effective way to keep costs down – or at least predictable – in the early years of your mortgage.
Drawbacks of a fixed rate mortgage
On the flip side, because the interest rate for fixed rate mortgages is set at a particular rate, you could potentially be losing out if the variable rate turns out to be lower than your arranged rate.
For instance, if the Bank of England’s base rate goes down, many banks will reflect the interest rate drop in their mortgage rates. However, if you’re on a fixed rate mortgage you’ll be stuck on the same rate as dictated by your mortgage agreement for the duration of time specified regardless of how low interest rates fall.
Ultimately this is a gamble. You could either end up benefiting if the interest rates are high during the first few years of your mortgage repayments, or you could end up paying more than necessary if interest rates fall.
It’s also worth being aware that fixed rate mortgages typically have high exit fees during the fixed rate period so you won’t be able to disengage from your agreement in the hope of securing lower interest rates without incurring early repayment charges.
Fixed rate mortgage considerations
- Interest rates go up and down
- There are typically early repayment fees for fixed rate mortgages
- Fixed rate mortgage terms usually last for two to five years
- Mortgage repayments stay the same for the duration of fixed rate terms
What is a variable rate mortgage?
In contrast to fixed rate products, the interest rate for variable rate mortgages can fluctuate throughout the whole course of your mortgage repayments. Consequently, your mortgage repayment can vary depending on the base rate and your lender’s decisions.
The way that the interest rates on your loan change will be reflective of the type of variable rate mortgage you have. There are two main types of variable interest rate:
- A tracker rate
- A standard variable rate
A tracker rate mortgage will follow the Bank of England’s base rate. The interest payable on your mortgage will therefore reflect changes in the economy and the base rate.
It takes a mature understanding of the overall national economy to predict the way that interest rates will change over the course of a few years.
If the base rate goes up, the tracker rate and consequently your mortgage repayments will also go up. If the base rate goes down, your lender will pass this drop on to you so you could benefit from a fall in your repayments. The interest rate on the tracker mortgage will usually be set a couple of percent above the base rate.
A standard variable rate on the other hand is set by the discretion of your lender and during the course of your mortgage will be changes as they see fit. This will usually still follow patterns set by the Bank of England’s base rate, but they could also increase the rate further if they wish.
Benefits of a variable rate mortgages
Opting for a variable rate mortgage opens the door to a potential drop in your mortgage repayments – particularly if you foresee the Bank of England’s base rate falling. This could reduce the overall interest you will have to pay on the total sum of your mortgage.
Drawbacks of variable rate mortgages
The gamble of course is that interest rates could potentially rise drastically and leave you with much higher monthly mortgage repayments that you hadn’t budgeted for.
It takes a mature understanding of the overall national economy to predict the way that interest rates will change over the course of a few years. If you make a decision based on a misunderstanding or simply take a gamble, you could end up finding interest rates rising to a level that make your mortgage repayments unfeasible.
Further, there’s the added risk that if interest repayments are high at the start of your repayment schedule you will end up paying a larger amount in total as it will be set against the overall outstanding sum of your mortgage.
Tracker rate mortgage considerations
- Tracker rates are usually set against the Bank of England base rate.
- Lenders have the power to increase and decrease your mortgage interest rate.
- Predicting national interest rates can be difficult.
- Interest is always set against the total outstanding sum of your mortgage.
Which mortgage is right for you?
There is no one right answer to choosing the best mortgage for you. However, there are a number of guidelines to keep in mind.
If you simply cannot afford the risk of interest rates going above a certain amount, then a fixed rate mortgage will give you some security until your financial circumstances give you more buoyancy to deal with fluctuating interest rates.
For those who can afford to weather the risk of higher interest rates, a desirable variable rate mortgage might allow you to take advantage of lower interest rates when the economy aligns.
Whatever you choose, make sure you understand the risk that you are taking and take time to research the options when choosing your eventual mortgage type.
General mortgage considerations
- Mortgages are a long term arrangement.
- Interest rates are hard to predict with certainty.
- Interest rates for fixed rate mortgages are only set for a specific duration.
- The interest rate of a variable rate mortgage can fluctuate dramatically.
- Always read the terms and conditions!