If you're remortgaging now, which deal should you go for next and for how long?
These days almost six out of ten borrowers choose fixed rate mortgages*. Seemingly, fix rates are becoming increasingly popular, but are they the best choice? Or would you be a fool to fix?
The fixed versus tracker debate has rumbled on for as long as I can remember. Not so very long ago, I backed tracker mortgages. Find out why here. But I think times have already changed.
Back then trackers seemed more attractive than fixed rates. Why? Because it looked like the Bank of England base rate was going to fall. So, borrowers with tracker mortgages linked to the base rate would benefit from any base rate cuts.
When you take out a tracker, the lender sets a margin between the base rate and the tracker interest rate you pay. So, for example, your tracker rate might be 1 per cent higher than the base rate (BBR +1%), which means you would pay interest at 6% today with the base rate at 5%.
Trackers are great when the base rate is falling. A quarter point cut to 4.75% would reduce your tracker interest rate to 5.75%, causing your monthly repayments to drop.
But the outlook for the base rate looks a little different now. We all know inflation is escalating. You probably feel the effects of rising inflation every day: higher food prices, higher fuel prices and so on.
If the Bank of England raises the base rate to stem inflation, borrowers with a tracker mortgage will find their rates increase too. Some pundits reckon the base rate could be up to 5.75% by the end of the year, which means that 6% tracker rate would step-up to 6.75%. Yikes!
Even though trackers don't fare well when the base rate is rising, they are -- generally-speaking -- priced more cheaply than fixed rates. Take a look at the table below:
Fixed Versus Tracker
Fixed Rates | Average Rate | Tracker Rates | Average Rate |
|---|---|---|---|
2 year fixed | 6.71% | 2 year tracker | 6.53% |
3 year fixed | 6.80% | 3 year tracker | 6.57% |
5 year fixed | 6.71% | 5 year tracker | 6.47% |
Source: Defaqto. June 2008.
As you can see the difference between the two is not as pronounced as you might expect, with trackers now less than 0.25% cheaper than fixed rates. There would only need to one quarter point (0.25%) increase in the base rate for a borrower who took out the average fixed rate now to be on a better deal than the average tracker.
So there's an easy argument for fixed rates today, but there's a bit more to it than that.
What about long-term fixed rates?
If you're remortgaging soon, it's worth considering a new long-term fixed rate deal. At one time the longer the fix, the higher the rate. But these days, the difference has become marginal. The most competitive five and ten-year fixed rates available today are actually the same at 5.99%. While, the best-buy two year fix is just 0.24% lower at 5.75%.
Given that there's barely a difference in rates for long and short-term fixed deals, I think there's a real incentive to fix your rate for longer.
There's three major reasons why now might be a good time to go for a long-term fix. Firstly, mortgage fees are rising so fast that remortgaging is becoming a costly exercise. By going for a longer-term fix -- and therefore remortgaging less frequently -- you could keep these costs down.
According to Defaqto, the average product fee for a two year fix is £823. On top of that, you may need to pay valuation and legal fees. So remortgaging every two years could become far more expensive than taking a long-term fixed rate instead.
Worse still, it's becoming more common for lenders to demand fees up front -- rather than adding the cost to your mortgage. So you may need more ready cash when you remortgage.
Secondly, a longer fixed rate should allow you to weather the credit crunch if it proves to be a long-term crisis. By fixing for ten years you should easily ride it out. This means payment shock -- when you can only remortgage to a more costly deal -- won't be a concern for you in the short-term.
And thirdly -- and perhaps most importantly -- fixed rates provide peace of mind. You'll always know how much your mortgage will cost during the fixed rate period. While your rate is fixed, there's no need to worry about interest rate hikes which you can't afford.
The downside of fixed rates
I can't deny there's a downside to fixed rates too. Although most are portable -- you can take the mortgage with you when you move house -- being stuck with the same lender for the next ten years might not appeal.
Worse still, if you need to get out early for any reason -- within the fixed-rate period and sometimes beyond -- there could be heavy early repayment charges (ERCs). Bradford & Bingley may have the answer with a ten year fix which only charges ERCs for the first five years. This is an unusual feature, but the deal is expensive at 6.99%.
But perhaps the greatest concern is that you could end up paying over the odds for your fixed rate if variable rate mortgages become cheaper. If the base rate falls -- instead of rising as expected -- borrowers with trackers will be laughing. But I think that could be a risk worth taking because mortgage rates don't look like they're going to drop any time soon.
Remember, rates are still rising for new fixed and tracker deals as the cost of funding mortgages increases for lenders. So my advice is this: if you see a great mortgage, grab it as quickly as you can because it won't be around for long.
*According to the latest data from the Council of Mortgage Lenders (CML).
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