Why length matters as much as the mortgage rate

Never mind the mortgage rate - is it better to go for a long or a short mortgage deal?

In February just 47% of borrowers went for a fixed rate, the lowest number in five years, according to the Council of Mortgage Lenders. Despite this, more people took a fix than any other type of deal. So even when they are at their most unpopular they are still the darlings of the UK mortgage market.

And it’s easy to see why.

Fixed rates are safe, secure and allow us to forget about the Base Rate for a while, in the knowledge that our mortgage payments will not alter until our specified deal comes to an end. It’s something worth paying a premium for in the eyes of many borrowers.

And pay a premium you will, with fixed rates still priced significantly higher than their equivalent deals. Trackers and discounts are cheap because you are taking a chance by getting one. It’s pretty obvious the only way is up for interest rates, whether it happens this year or further down the line. Fact is, if variable rate deals weren’t so cheap, why would anyone take the risk?

If you prefer the security of a fix you still have one big decision to make. Do you go for a long or a short-term deal?

Short and sweet

The advantage of taking out a short-term fixed rate is that they are significantly cheaper than longer term deals.

The average two-year fixed rate is currently 4.64% for example, compared to the average five-year fixed rate at 5.84%, according to financial information provider Moneyfacts. But how does this translate in terms of cold hard cash.

Well, if you borrowed £150,000 on a repayment basis over 25 years the average two-year fixed rate would cost you £846 a month, which would total £10,152 a year.

The average five-year fixed rate would cost you £106 more every month at £952, and over a year this would be £11,424.

That's £1,272 more than the short-term fix.

Those with a bigger mortgage would see an even greater savings by going for the cheaper two-year deal.

If you borrowed £300,000 on a repayment basis over 25 years the average two-year fixed rate would cost you £1,691 a month, compared to the average five-year fixed rate which is £213 more every month at £1,904 - a massive £2,556 more a year than the short-term deal.

Of course, in all cases you would have additional arrangement fees to add on. But it shows that on average a short-term fix is going to cost you substantially less than a long term deal.

• Watch this video: Cut the cost of your mortgage!

Looking past the averages

But never mind the averages. lovemoney.com readers are interested in the best buys, not run of the mill deals. So how do the best short and long-term fixes stack up?

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The cheapest two-year deal I could find is 2.89%, offered by Alliance & Leicester for Intermediaries. And the cheapest five-year fix is 4.49% from The Co-op Bank (see tables for details).

It’s a huge rate difference and on a £150,000 the two-year fix would cost you £703 a month and £8,436 a year, while the five-year deal comes in at £833 a month and £9,996 a year. That’s £130 a month more for the five-year deal, which is £1,560 a year higher.

So why would anyone go for the long-term fix?

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Lock in for longer

That’s easy. With a five-year fix you are paying for payment security for five whole years. No matter what happens to interest rates your payrate will not change.

Related blog post

• John Fitzsimons writes:

  Should you get a fixed rate or a tracker?

  With interest rates languishing at record lows, is now the time to take advantage with a tracker, or go for the safe option of a fixed rate?

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While some people believe interest rates could remain low, or at least relatively low for the next year or two, many economists think they will rise in the medium term. By locking into a low rate for the next two years you protect yourself from those rises.

You will certainly pay more in the first two years than those on a short-term fixed rate, but in years three, four and five you continue to pay the rate you have secured, whereas they will be flung back into the mortgage market at a time when rates are more likely to have risen. And the increased mortgage rate that they could end up paying once their two-year deal is up might mean they pay more than you overall.

Of course, it might be the case that rates remain low indefinitely and those on a long-term fix pay over the odds for the whole five years. That’s the chance you take.

But by paying a premium now you are giving yourself total payment security for the entire duration of your fixed rate.

• Read this blog: Should you get a fixed rate or a tracker?

No more switching

There is another benefit to taking a long-term deal. Remortgaging is nobody’s idea of fun and despite having been made quicker and easier in recent years, let’s face it, there are more interesting things you could be doing than filling in forms and searching for mortgage deals.

If you lock in for longer you don’t have to switch after two years, and again after four years. Not only do you miss out on the hassle, you are likely to save typically around £2,000 on switching costs by taking a long-term deal.

Less time, less money and less worry.

There is no right or wrong decision on whether to lock in for the long or the short-term. Whatever works for you is the right option, and below are some of the best short- and long -term fixed rates:

15 top two-year fixed rates

13 Fab five-year fixed rates

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