Fix your mortgage rate now!

With interest rates set to rise, you'll save thousands if you get one of these top fixed rate mortgages now, argues Jane Baker.

Choosing the right deal when you remortgage can be a very tricky decision indeed. Without the aid of a crystal ball, how can you ever know the rate you settle on now will stay competitive in the future?

Quite simply, you can't. But that doesn't mean you can't make a well educated guess.

Fixed versus tracker

For some borrowers, the security of a fixed rate wins every time. There's absolutely nothing wrong with that. If your budget can't withstand an increase in your mortgage repayments, then a fixed rate is surely the safest choice. That said, tracker borrowers who got in at exactly the right time are now enjoying super low interest rates. Good for them.

There's certainly a mixed appetite for each type of deal. According to data from mortgage lender, Santander, only 13% of homeowners, who are due to remortgage in the next six months, said they would choose a tracker. That figure has dropped from 33% in one month. Meanwhile, the number of borrowers who said they would go for a fixed rate has increased from 20% to 23%.

On the other hand, mortgage broker, John Charcol, says four out of five mortgages the company arranged in December were variable rates.  

The tide has turned

There's no question that low rate trackers look attractive, but all good things must come to an end. I think the tide has turned, and now fixed rates are the better option.

Fortunately, competition in the fixed end of the market appears to be hotting up. Lenders are becoming less reliant on swap rates for funding fixed rate mortgage lending. Instead they're now relying more heavily on deposits from savers, which are enabling some to cut rates.

Having said that, I can't deny there's still a significant margin between fixed and tracker rates. Just take a look at the tables below which outline the top deals for borrowers who have a 40% equity stake in their home. First up it's the fixes:

Top fixed-rate mortgages at 60% LTV over two, three and five years

Source: Moneyfacts. The deals shown are for remortgages.

Next up it's the top trackers over two and three years, followed by lifetime deals:

Top tracker mortgages at 60% LTV over two and three years and lifetime deals

Source: Moneyfacts. The deals shown are for remortgages. There are no trackers deals available for five years exactly, therefore lifetime trackers have been used instead.

Alliance & Leicester offers the lowest rate two-year fixed deal and the lowest rate two-year tracker deal (but watch that hefty 2% product fee which could push up the cost of these deals significantly depending on the amount you borrow). The 3.15% fixed rate is 1.16% higher than the pay rate on the tracker, which is currently just 1.99% (bank base rate + 1.49%).

But what does the difference between the two rates mean in terms of actual monthly repayments?

Based on a mortgage loan of £120,000 over 25 years, the fixed rate deal would cost £578.46 a month; while the tracker would set you back just £508.04. So, choosing the tracker would cost £1,690 less if the rate stayed exactly the same for the two-year period. It's a similar story when measuring the longer-term fixes against the longer-term trackers.

With potential savings like this to be had, why would any borrower decide against a tracker?

Rates are set to rise

The trouble with trackers is we know what the pay rates are today, but we have no idea what they might be next month, next year and beyond. If the base rate increased to say, 2% by the end of the year, the two-year fixed rates would then be lower than the pay rates on the equivalent tracker deals.

You may not think it's at all likely that the base rate will reach this level in 2010. But I think we would all agree, once the economy strengthens, the base rate will eventually normalise. On top of that, with inflation already racing, the base rate could rise a lot sooner than you might think.

How long should you fix your rate?

If you think a fix is the way to go, how long should you fix for? Personally, I would favour five years over two years for two reasons: firstly, fixed rates might look expensive when compared with trackers, but the five-year deal from HSBC with a rate of 4.73% looks like pretty good value to me historically.

Secondly, short-term fixed rate deals aren't always as cheap as they seem. Some lenders whack on huge product fees which can easily wipe out the benefits of a low rate. Plus there may be extra remortgaging costs to pay if you choose a short-term fix, rather than a longer-term one.

Even worse, the risk of rates rising in the meantime could land you with much higher repayments in the future than you would have had by choosing a five-year fix now. To find out more about this take a look at Avoid this massive mortgage mistake.

Is a tracker ever a good idea?

If you're still not convinced fixed rate deals have the edge, I suggest you opt for a lifetime tracker. A lifetime tracker mortgage tracks the base rate at the same margin for the term of the loan.

But you should always make sure you choose a deal which doesn't incur early repayment charges if you change your mind. This will allow you to remortgage elsewhere if the rate rises too high, without triggering a penalty from the lender for leaving.

Of the deals shown in the table, both HSBC and First Direct offer this type of deal. But Woolwich charges 1% of the balance you have repaid if you switch to another lender before 1 May 2012.  

If the fixed or tracker decision is still causing you headache, help is at hand. You can speak to one of our brokers at the award winning lovemoney.com mortgage service. You can also ask other lovemoney.com readers for their opinion using our Q&A tool. Finally, once you've decided which deal suits you best, join our Cut your mortgage costs and pay your mortgage off early goal to help you reach that mortgage-free day as soon as possible.

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