What Is The Best Mortgage Deal?

We look at whether you should opt for a fixed-rate or variable-rate mortgage.

Should you opt for a fixed-rate or a variable-rate mortgage? It's a question every mortgage borrower asks at some point during the mortgage process, and unfortunately, there's never an easy answer.

Why not? Because the right mortgage to get right now will always depend, to some extent, on what's going to happen to interest rates in the near future.

If you had a crystal ball which showed interest rates were certain to go up within the next couple of years, you would probably want to consider a fixed-rate mortgage, because with a fixed-rate, your monthly payments are set at a certain level every month, and are not affected by hikes in interest rates.  

If, on the other hand, the crystal ball showed interest rates would go down shortly -- as in fact many economists are predicting right now -- you might want to consider a tracker or a discount-rate mortgage.

Why? Because a tracker tracks the Bank of England base rate at a set distance. It's like a mortgage payments bloodhound -- when interest rates fall, your payments will also fall. What's more, if you get a lifetime tracker (such as Marsden Building's Society's Base Rate +0.19% tracker), you need never suffer the hassle and cost of remortgaging - because it tracks the base rate, your rate should always be relatively similar to the new deals on offer on the market.

Similarly, payments on a discount-rate mortgage also drop when interest rates drop. This type of mortgage offers a discount off the lender's standard variable rate (SVR). The SVR is decided arbitrarily by the lender, but is typically around 2% higher than most fixed-rate, tracker and discount deals.

A discount-rate mortgage is less transparent than a tracker, as it is not overtly linked to the Base Rate. However, in practice, lenders usually move their SVR up and down in line with Base Rate decreases and increases, so a discount should still work out to be pretty competitive.

What if?

Before you race off to compare discount and tracker mortgage deals, what if the economists are wrong and interest rates go up? If you had a tracker or a discount mortgage, your monthly payments would go up - while you would be protected from any rate hikes if you opted for a fixed rate.

The flip side is, if interest rates go down, and you're got a fixed rate, you'd be stuck on a relatively expensive rate. Most fixed rates come with early repayment charges (ERCs) which penalise you if you remortgage during the fixed-rate period (typically you are expected to pay around 3% of the outstanding loan).  So you wouldn't be able to switch to another deal, which means you wouldn't benefit from lower payments following a drop in interest rates.

Either way, it's a gamble. And before you can make a decision, what you really need to know is: how much will it cost you?

Work It Out

To work out the total cost of a mortgage deal:
1) Figure out your monthly repayments using our Mortgage Calculator. You'll need to know the interest rate of the deal and your remaining mortgage term (if you're a first-time buyer, it's usually 25 years).
2) Multiply the 'monthly payment for a repayment mortgage' by the number of months you plan to stick to that deal. So if it's two-year deal, multiply it by 24.
3) Add on the fees to this sum.
4) Divide by the number of years you plan to stick to the deal. So if it's two-year deal, divide by two.
This will give you the total cost per year of that mortgage deal.

To try to get an idea about how expensive the different types of deal currently are in relation to each other, I've used the above formula worked out the average rates and fees of both fixed rates and trackers/discounts, using our top available Mortgage Best Buys as of 15 November 2007. I then calculated the average total cost of these deals per year, on the basis that I wanted to take out a two-year deal on a £150,000 25-year repayment mortgage.

NB: to get an up-to-date version of this calculation, our Mortgage Service can figure all this out for you.

As these tables show, a tracker/discount would still work out slightly cheaper right now -- that's if interest rates remain steady, instead of falling, as many predict. However, if you went for a tracker or a discount mortgage deal, you would not benefit from the peace of mind and security that comes with a fixed rate - and that may be worth paying extra for.

The fact is, there is no such thing as the `best mortgage deal'. It's up to you. If you are on a tight budget, or you believe the Base Rate is going to rise, then a fixed rate is probably the best choice. But if not, then you may well better off with a tracker or a discount mortgage deal. You can get fee-free professional advice on the best deals, using the Motley Fool Mortgage Service.

Of course, there is one final option. Acquire a crystal ball... and when you're done with it, send it to me, c/o The Motley Fool, Great Pulteney Street, London. I really could use one.