Learn to be a Financial Hunter - Not the Hunted
|
|
|
|
|
|
|
You Are Here: Home > Personal Finance > Mortgages > Different styles > Fixed Rate Mortgage
Fixed Rate Mortgage

What are they - How they work - Pros & Cons

Want to improve your credit rating? Consider using a low-limit Credit Card as a strategy of monthly borrowing and repaying. It works wonders. Find out more.
A fixed rate mortgage is where the interest rate is fixed for a certain period of time, usually between 1-5 years but can be longer. For example -

  • 2 year fixed interest rate of 4%
  • 5 year fix at 5%, and
  • 10 year fix at 5.75%
As the interest rate is fixed it doesn't matter if the official Bank of England interest rate rises or falls, the monthly payments always stay the same. This is obviously good news when interest rates are climbing higher but not so good when they're falling as the mortgage payments won't decline.
Fixed mortgages are excellent for long term planning

The main selling point of a fixed rate mortgage is peace of mind because if interest rates rise the monthly payments will always stay the same. This in turn means they have a downside - if interest rates fall the monthly repayments won't shrink.

But my take on this is simple - when it comes to money it's far more important to protect your downside especially with such a large loan as a mortgage.

Sadly many people have got into serious financial trouble in the past by -

  • Taking out large mortgages (in relation to their incomes) when interest rates were low
  • But then when rates started to rise they struggled to make the payments
  • And in extreme cases this has led to the home being repossessed
So my advice is to think long and hard about your personal budget to see if you'd be able to handle interest rates rising by 1%, 2% 3% or more. If not then a fixed rate deal is probably for you.
How long to fix the interest rate for

2 years is the average for most fixed rate mortgages but plenty of 5 year deals are always available. Sadly not many lenders offer 10+ years which is a shame as 15 year and 20 year fixed deals are common in both America and in continental Europe.

So how long to fix?

This is obviously a personal decision as everyone's financial situation is different but if you agree with my argument that fixed rate deals are great for personal budgeting then try to fix for as long as possible.

Do note however the longer you fix for the higher the interest rate will be, for example if a lender offers a 2 year, 5 year and 10 year fix expect to see the rates look something like this -

  • 2 years at 3.5%
  • 5 years at 4.15%
  • 10 years at 5.5%

The 2 year deal with a fix at 3.5% looks the best rate and this is true in the short term. But think what might happen if interest rates were to climb to 5% or more over that period. Having the 2 year fix would be an advantage but only for 2 years and when the fix expired you'll be paying the lender's SVR which is likely to be 6% or higher - more information on SVRs on the interest rate page.

My point is don't just think about the short term savings when fixing a mortgage rate, think long and hard about what happens after the fix expires. And for many this means trying to balance the best long term fix over the costs involved (higher interest rates payable and possibly higher arrangements costs).

How interest is charged
As discussed above the longer the fix (in years) the higher the interest rate. And this can make many long term fixes, greater than 10 years, look very uncompetitive. For example -
  • 2 year fix at 3.5% with arrangement fees of £499
  • 15 year fix at 7.45% with arrangement fees of £1499

Clearly the interest rate and the arrangement fees on the 15 year fix are outrageous but this is how the lenders often price 11+ fixed rate deals.

Ultimately this means the best fix is probably in the 5 year range and this balances a decent number of years with competitive prices.

Positives


  • Peace of mind - No matter how high interest rates go your interest rate will stay the same

  • Simple to understand - the best financial products including mortgages are normally the simplest. See Secret 3 - Buy simple and flexible - you can't read the future - which is one of this site's 10 Secrets to Good Personal Finance

  • Great news when rates are rising - if interest rates rise significantly there's no better mortgage to have than a fixed rate one

  • Plenty of competition - All the lenders offer fixed rate deals meaning plenty of competition which always leads to good deals

Negatives


  • Higher interest rates - fixed rate deals will always charge more interest but think of the extra cost as an insurance policy. Remember, if you own a car you'll pay insurance whether it's needed or not. More on Mortgage interest rates

  • Repayments won't fall if interest rates are cut - When interest rates fall your mortgage rate will stay the same, ie you won't benefit from cheaper monthly repayments

  • Possible jump in monthly repayments when the fix expires - say a 25 year mortgage is taken out with the rate fixed at 5% for the first 5 years. When the 5 year fix expires official interest rates are 7%. If so your monthly repayments will jump significantly

  • High early repayment chances - If you want to get out of the deal during the fixed rate period there will normally be costly early redemption fees to pay. See Mortgage Fees & Charges

  • Higher costs for longer term fixes - if you want to fix for more than 5 years the lenders normally charge higher costs than other mortgage styles

Buying tactics, tips and tricks

Want the right mortgage at the best price? Then start by downloading our free mortgage guide and follow the 4 easy steps.

  • Shop around - Fixed rate deals are common, all the lenders will promote them so shop around for the best deal - see how to compare mortgages

  • Watch the early redemption charges - Costly early repayment/redemption fees are sort of fair when the fix is in place but still, there is expensive and very expensive, so make sure you fully research how a number of different mortgages charge these fees

  • Be quick - Interest rates, or at least the expectations of the future direction of rates can change quickly, so a fixed rate deal is sometimes marketed for only 1-2 weeks. So if you see the right one it's best to act quickly

  • Watch the arrangement fees - many lenders charge far more than they should for longer term fixed rate deals (5+ years) so be on the lookout
LearnMoney.co.uk comment :
I couldn't be more positive about fixed rate mortgages if I tried because they're all about sensible long term financial planning.

However, their downside is although 10+ year fixes are offered the costs and interest rates are normally too high. Still, keep your eyes open as the lenders do sometimes offer some good deals.

To summarise - fixed rate deals offer security, yes you have to pay extra by way of a higher interest rate but think of this as an insurance policy.

FREE Report: How to get the right mortgage at the best price
It takes just 4 easy steps
How to make sure you don't overpay on charges
Learn to quickly sort through the market maze
How to get a flexible deal - why this is so important
Download the Free Report
[an error occurred while processing this directive]

© 2017 LearnMoney.co.uk All rights reserved

The information on the LearnMoney.co.uk website has been compiled from sources believed to be reliable, but is not warranted to be accurate or complete.
All recommendations and comments are provided for general interest only and should not be construed as advice.
Professional advice should always be sought before buying or investing in any financial product.
The price of securities and any income from them can go down as well as up.
Past performance of a security or market is not necessarily indicative of future trends.
Any opinions and recommendations on LearnMoney.co.uk are given in good faith, but without legal responsibility and are subject to change without notice
.