Short and sweet mortgage deals

We look at two-year fixed rates vs two-year variable rates.

British borrowers love a short-term mortgage deal. There is a certain feeling of freedom that comes from not locking into your mortgage rate for the longer term, and knowing that should interest rates change dramatically, you have the option of switching deals to suit. And historically lenders have offered more competitive deals to those who chose a short-term product.

The British government has long championed the long term rate -- specifically the long-term fixed rate -- and has tried to get British borrowers to come around to the idea. Back in 2003 it commissioned Professor David Miles to produce a report that told us long-term fixed rates offer better payment security, protecting borrowers from the vagaries of interest rate movements and helping us to budget.

But UK borrowers were not keen, and it would take far greater choice of competitive long-term deals to get us to bite. Our European cousins may be happy to lock in for the long term, but we are not.

In the current market I actually believe that medium and long-term fixed rates are the smartest choice, as I explained recently in Long-term fixed rates rule. Nevertheless, short and sweet deals are what the UK borrower wants.

So if you only want to commit to two years, should you go for a fixed rate or a variable rate mortgage (tracker or discounted rate)?

Stick or twist?

On the face of it, two-year fixed rates are currently more expensive than two-year tracker rates, and significantly so.

The current average two-year fixed rate is 4.73% and the average two-year tracker is 3.56% according to financial information provider Moneyfacts.

On a typical £150,000 25-year repayment mortgage, the average two -year fixed rate would cost £853 a month compared to just £756 for the average two-year tracker. This is almost £100 a month cheaper, and over £3,200 less over the course of a two-year deal.

In addition, the average fixed rate mortgage fee is £966 compared to a slightly cheaper £946 for the average tracker rate fee.

So it pays to take a tracker, right? Well, not necessarily.

Potential to rise

The average two-year tracker is currently 3.56% and we have a Base Rate of 0.5%, giving a wide margin of 3.06%.

When the Base Rate rises, average tracker rates will increase at this margin. This means the Base Rate only needs to increase to 1.75% before tracker rates become more expensive than current fixed rate deals.

At Base Rate of 1.75% the average tracker at today's margins would be 4.81%, more expensive than the average fixed rate.

In other words, a major factor in your decision between fixed and tracker rate mortgages will be what you think will happen to interest rates. If you believe Base Rate will increase to 1.75% or more in the next two years, fixing looks like a more attractive option. If you think it will stay below 1.75% you would be better off with the tracker.

In reality, we can't predict what will happen, but if you don't want to take the chance or cannot afford your rate to go much higher than say, five per cent, it could be worthwhile locking into a fixed rate.

Remember that Base Rate could go a lot higher than 1.75%. Just last year it was at 5.25%. If it went back to that level, today's average two-year trackers would rise to 8.31%. Ouch!

With a fixed rate, you know exactly what your monthly repayment will be for two years, no matter what happens to interest rates.

Best of the bunch

Average trackers may be significantly cheaper than average fixed rates, but what about the best buys?

Those with a 40% deposit will be able to find some really cheap deals across the board while borrowers with a 25% deposit still have a good choice of competitive two-year fixed, discount and tracker mortgages to choose from.

However, those with just 10% upfront will find that the rates available to them are significantly higher, plus they will be forced to take a fixed rate if they are looking for a two-year deal, as there are currently no trackers available.

It's worth mentioning that many trackers come on a 'term' basis, not as two-year deals, so you can take out the mortgage and usually remortgage at any time without penalties. I have only included two-year trackers in the comparison tables below for the sake of consistency, but it is well worth checking out term trackers across the 60% and 75% LTV tiers as they include some of the best rates in the whole market.

Below are my picks for the best two-year fixed, discounted and tracker rates at 60%, 75% and 90% LTV:

Two-year deals -- fixed v variable (including trackers and discounts)

60% loan-to-value

*available up to 65% LTV

75% loan-to-value

*available up to 80% LTV

90% loan-to-value

You will notice there are no examples of two-year variable rates at 90% loan to value. I'm not aware of any currently available, although borrowers with a 10% deposit who don't want to fix may be able to choose from longer-term variable rates -- for example some lenders still allow new borrowers onto their standard variable rates.

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