Borrowers are piling into fixed rate mortgages, but should you lock in for the long term, or stick with a short-term deal?
With average fixed rate mortgages at their lowest-ever levels it’s easy to see why borrowers are flocking to the safety of a rate that is guaranteed not to move for the duration of the deal.
This is the case even against the background of all-time low interest rates that are predicted to remain low for the next few years.
The British public are more cautious than ever – all too aware that there are no guarantees, and also that lenders can move their rates upwards whatever happens to base rate, as we saw the Bank of Ireland do with its tracker deals last month. Read Bank of Ireland UK Base Rate tracker mortgage customers hit by rate rise for more.
Most borrowers are firmly in the fixed camp, which only leaves one question. Should you fix for the short term or the long term?
The case for staying short
If you want the absolute cheapest fixed rate you can get your hands on, a short two-year fixed rate mortgage is the way to go. A few deals are available at less than 2% interest for those with large deposits, and at every LTV tier, it’s the two-year deals that sit at the top of the best buy tables.
Borrowers have traditionally gone for these popular short-term deals because, as well as being cheap, they require no long-term commitment. Your rate is guaranteed for two years, plus you get the chance to choose again in 24 months’ time.
If the market has improved, you can switch to a better deal without penalty, and if the Bank of England decides to set interest rates low for a specific period of time – an idea which has been mooted – who knows how much lower fixed rates could go? Of course, rates could also have risen in two years’ time.
Short-term fixes also suit borrowers who don’t want to commit to their particular property for the long term, because longer-term deals come with hefty penalties if you want to get out the deal early.
It’s worth noting that most long term fixed rate mortgages are ‘portable’ to a new property in theory, but in practice this may not be possible if you want to borrow more to move to a larger home for example.
If your lifestyle or circumstances mean you do not intend to stay in your property for more than a few years, a short-term deal may be more suitable.
Playing the long game
Locking into a fixed rate for the long term offers one tremendous bonus – your rate of interest is set in stone for a longer period.
This means you can sit back and relax about your monthly mortgage payments as they are guaranteed not to rise for a lengthy period and, for many, this peace of mind is worth paying a premium for.
Even better news is that the premium at the moment is miniscule, with the gap between the best two-year and five-year deals extremely small. There are now five-year fixed rate mortgages available at under 3% - a seriously low rate of interest for medium-term security.
Another advantage to a long-term fixed rate is that you only pay your mortgage arrangement fee once for every deal you take. If you switch between two-year deals you pay a new fee every two years, but a longer-term fix would mean you avoid that extra set of switching costs 24 months down the line.
When you consider that the average arrangement fee is over £1,500 according to Moneyfacts, this could mean a significant saving. Fix for ten years and you only pay that fee once, not five times!
But what about the overall cost?
Which is cheaper?
Below I have compared the lowest two-year fix to the lowest five- and ten-year rates I could find, taking into account arrangement fees.
The lowest two-year fixed rate currently available is 1.74% from Chelsea Building Society which comes with a fee of £1,545.
The lowest five-year fix is 2.64% from First Direct with a fee of £1,395, and the lowest ten-year fix is 3.99% from Norwich & Peterborough Building Society with a tiny fee of £295.
The table below shows what you would pay for each deal over the first two years on a 25-year repayment mortgage of £100,000.
|
|
Rate |
Monthly repayments on £100,000 mortgage |
Total in repayments over first two years |
Arrangement fee |
Total cost over first two years |
|
Two-year fix |
1.74% |
£411 |
£9,864 |
£1,545 |
£11,409 |
|
Five-year fix |
2.64% |
£456 |
£10,944 |
£1,395 |
£12,339 |
|
Ten-year fix |
3.99% |
£527 |
£12,648 |
£295 |
£12,943 |
[SPOTLIGHT]However, problems arise when you try to compare short- and long-term fixed rates over more than two years, because the two-year deal has come to an end.
In year three the two-year fix at 1.74% from Chelsea Building Society would revert to the lender’s standard variable rate of 5.79% - on a £100,000 mortgage this means monthly repayments would rocket from £411 to £632, making it much more expensive than the five- and the ten-year fix from this year onwards.
But of course this isn’t a fair comparison, since most borrowers would choose to remortgage to a new deal at the end of a two-year fix, especially when faced with the prospect of defaulting to a high SVR.
What we don’t know is what sort of rates will be around in two years’ time and that’s why the comparisons are impossible. Borrowers can never know what sort of market they will be coming out into.
It’s each to their own of course, but if I could bag a five-year fix at less than 3% I would take that medium-term security over saving a little on a super-low two-year deal.
Below are some of the best fixed rates on the market right now, whatever your deposit:
Fab fixes
|
Lender |
Type of deal |
Rate |
Fee |
Max LTV |
|
Two-year fix |
1.74% |
£1,545 |
60% |
|
|
Two-year fix |
2.29% |
£995 |
75% |
|
|
Five-year fix |
2.64% |
£1,395 |
60% |
|
|
Five-year fix |
2.89% |
£1,349 |
75% |
|
|
Two-year fix |
3.69% |
£1,545 |
90% |
|
|
Ten-year fix |
3.99% |
£295 |
75% |
|
|
Five-year fix |
4.20% |
Fee-free |
90% |
|
|
Seven-year fix |
5.09% |
£375 |
90% |
What do you think? How long would you fix your rate for? Let us know your thoughts in the comment box below.