Clive Read, November 2023
We are living in turbulent economic times. The ever-increasing cost of living has driven inflation, leading The Bank of England to increase the interest rate no less than 14 times in the past two years. With interest rates now at a 14-year high, the cost of borrowing is a significant concern, and many homeowners are left wondering if they should fix the term of their mortgage and, if so, for how long.
The choice of a 2 or 5-year fixed-rate mortgage depends on your finances, deposit, long-term plans and appetite for risk. Longer fixed-rate deals offer stability, which is attractive in economic uncertainty. But you may be charged if rates drop and you wish to remortgage sooner to get a better deal.
This is the dilemma many of my clients are now facing. Should they go for a two-year term in the hope that interest rates will fall and they can take advantage of a lower interest rate when the fixed rate period ends? Or should they look to beat rising interest rates and lock into a five-year mortgage?
I’ll look at the pros and cons of fixed rates in this article, explore the alternatives, and delve deeper into how to decide between a 2 or 5-year fixed mortgage.
What does it mean to ‘fix’ my mortgage?
Fixed-rate mortgages lock in the current interest rate at the beginning of the loan, meaning that your mortgage payments will remain the same over your chosen period. This is opposed to variable rate mortgages, more information on which can be found below.
Mortgage lenders set their rates on their expectations of future interest rate rises, as predicted by the financial markets.
How do fixed-rate mortgages work?
With a fixed mortgage, your monthly payments are agreed upfront for a period of your choosing, typically 2, 3, 5 or 10 years. Some lenders offer even longer multi-year fixes for the whole mortgage term.
Once the fixed term ends, the mortgage typically transitions into the lender’s standard variable rate (SVR), which can result in rate changes and variable payments unless you choose to refinance or renegotiate a new fixed-term mortgage.
What is the alternative to a fixed-term mortgage?
Instead of a fixed term, you can opt for a variable mortgage deal, also known as a standard variable rate (SVR) mortgage. In this type of mortgage, the interest rate can change at the discretion of the mortgage lender.
Lenders typically set their SVR based on the Bank of England’s base rate and other market conditions, but they can change it independently. Borrowers with variable mortgages may experience changes in their monthly mortgage payments when the lender adjusts the interest rate.
Another alternative is a tracker mortgage, which is a different type of variable rate deal. More on tracker mortgages later, let’s look at the pros and cons of a fixed-rate deal.
Advantages of a fixed-rate mortgage deal
The primary advantage of a fixed mortgage is the financial stability it provides, as the interest rate remains unchanged throughout the loan term. This ensures predictable monthly payments, shields you from the impact of rising interest rates, and helps you budget for the long term.
For this reason, a fixed-rate mortgage can be a good option for risk-averse or budget-conscious homeowners and those looking to stay in their homes for the long term.
Disadvantages of a fixed-rate deal
The major disadvantage of a fixed mortgage deal is that in the event of falling interest rates, your payments will remain fixed, and you won’t benefit from the lower rate. You will be effectively stuck paying your agreed rate for the duration of the loan.
While it’s possible to exit a fixed-term mortgage early and seek a cheaper deal, it usually comes at a price. Many lenders impose early repayment charges (ERP), typically between 1 and 5%. Depending on how high the charge is, it may negate the savings in the short term, at least.
That said, in some circumstances, it can be worth exiting a fixed-rate deal early as the cheaper rate may offer an overall saving despite the early repayment charge.
Will the interest rate go down?
The Bank of England has a target of 2% inflation, which they have been endeavouring to reach by hiking the interest rate. But even they insist they can’t predict how interest rates will fare in the light of world events. While some shifts on the world stage are easier to plan for, such as Brexit, crises like the pandemic and the war in Ukraine are impossible to see coming.
With conditions as they stand, the Bank of England predicts that inflation should reach normal levels by the end of 2025. As for when and if interest rates fall in line with this is harder to predict. As a homeowner, all you can do is keep yourself informed of the most recent changes and seek the advice of a professional mortgage advisor to weigh up the pros and cons, depending on your personal circumstances.
Correct as of November 2023.
2-year versus 5-year fixed mortgages
In this time of economic uncertainty, deciding between a 2 and 5-year fixed-rate mortgage is not an easy task. Should you take a 2-year fixed-rate mortgage now and keep your fingers crossed that the interest rate falls? Or should you lock into the current rate for five years lest it continues to skyrocket?
There is, of course, no way of looking into the future, and we can only predict what will happen to the rate over time. It’s widely reported that the interest rate has peaked or almost peaked, but nobody can be sure.
Given this uncertainty, the answer to the question “Is it better to do a 2 or 5-year fixed mortgage?” is very much down to the borrower’s personal circumstances.
How long should I fix my mortgage?
The current state of the economy aside, let’s look at the considerations that affect the choice between a two or five-year fixed mortgage.
First-time buyers may be more comfortable with a two-year fix for the following reasons:
- They want the flexibility to sell the property sooner if things don’t work out.
- With 5% mortgages on the rise, a first-time buyer may have a high loan-to-value. After two years, the combination of capital repayment and (hopefully) an increase in the property price will likely result in a higher equity position. This means they can potentially remortgage at a more advantageous LTV.
- They want the flexibility to sell the property after two years and move to another, perhaps bigger, property.
Your deposit may also affect your choice between a two and 5-year fixed mortgage. With a higher LTV (of 15% or more), a longer fixed term will likely result in a more favourable mortgage rate. So a 5-year fixed term may be more appealing than a 2-year fixed term in this scenario.
If your income and monthly budget are stable, you may be more comfortable with a 5-year fixed mortgage, which provides long-term predictability in your monthly payments. If you have a more flexible budget and can adapt to potential payment fluctuations, a 2-year term, or even a tracker mortgage, might be more beneficial.
If you are in your “forever home”, it may be more attractive to lock into a longer-term fix and concentrate on repaying the mortgage and protect yourself against future interest rate rises.
Appetite for risk
Unless you are a keen observer of the financial markets, the risk of the interest rate rising may be too much to bear. Even if you are a finance professional, there is no guarantee your predictions will materialise. So, it boils down to how much of a risk you are willing to take, which often correlates to the size of your budget.
Should I consider a tracker mortgage deal?
A tracker mortgage deal is linked to the Bank of England’s base interest rate. It is, therefore, variable and will rise and fall in line with the base rate. Generally, the rate is charged at a percentage over the base rate, e.g. base rate plus 0.5% for two years.
The advantage of this over fixed mortgage rates is that if the base rate starts to fall, the mortgage rate will also fall, resulting in lower monthly repayments. Conversely, the major disadvantage of this kind of mortgage deal is that with rising interest rates, the mortgage loan and monthly repayments will become more expensive.
In the past, some borrowers were lucky to take tracker mortgages that were base rate minus a certain percentage. This meant that when base rates fell dramatically, which they did in 2008, they effectively paid no interest on their mortgage, though they still needed to make capital mortgage repayments.
On the other hand, if you took a tracker mortgage back in 2020, you would have had somewhat of a tumultuous ride in the past three years! However, one of the critical advantages of tracker mortgages is that there are often no early repayment charges. So, in theory, you may have been able to exit the deal early to switch to a cheaper deal.
How can Goldmanread help me?
Choosing the right mortgage is no easy task, so the advice of a professional, independent FCA-registered mortgage broker with a great deal of knowledge about the mortgage market, like Goldmanread, can be very valuable.
Whether you are seeking a fixed deal or a variable-rate mortgage, we can advise you on the range of mortgage rates across the market. Our only goal is to make the mortgage process easier, help keep your mortgage costs low and save you money.
As fully regulated mortgage brokers, we will listen carefully to your requirements and provide full written advice on how we advise you to proceed with your new mortgage. Considering current interest rates and, crucially, your circumstances, we can help you decide on the length of your fixed-rate period if it is suitable.