For the last decade mortgage interest rates have been at all-time lows, meaning the decision to fix these low mortgage rates has been straightforward with the only decision being how long to fix for – 2 years, 3 or 5?
2022 sees the end of this era. Interest rates have almost tripled this year and are still on the rise, resulting in significant monthly repayment increases as mortgage deals come to an end.
Mortgage holders are now faced with different decisions in the current climate: is the traditional fixed rate approach of the last decade still appropriate? Below we examine the types of mortgage rates available, specifically fixed, tracker and variable rate mortgages, and assess their pros and cons. It’s more important than ever that clients discuss their options with their mortgage adviser to make the right choices in this new mortgage era.
Fixed Rate Mortgages
The main benefit of a fixed rate mortgage is the certainty. You know exactly what the cost of the mortgage will be over your fixed period and how much you’ll pay each month. This allows you to budget effectively during that period and gives you peace of mind. Yes, fixing your mortgage at 6% now feels crazy (compared to the sub 2% rates previously on offer), but if those payments are still affordable to you then this could be the safest option. Could you afford the rates if they went any higher? If your answer is no, then fixing your rate will protect you against potentially even greater future costs that might come with any sort of variable product.
On the other hand, if rates start to fall you’ll be locked into that fixed rate for a defined period and will not be able to take advantage of the savings that could be made. You could remortgage to a more preferential rate at this point, but if you end your fixed rate early, you may incur large early repayment charges.
Pros and cons of a fixed mortgage rate:
- Certainty of knowing your monthly repayments for a period of time to allow you to budget efficiently.
- Your payments will not go up during your initial fixed rate term, no matter how high rates go.
- If interest rates fall, you won’t see a reduction in payments.
- If you want to get out of the deal early you will have to pay early repayment charges, which can be quite hefty!
Tracker rates are currently looking quite attractive as they are usually a few percentage points above the Bank of England (BoE) base rate: this means they will be lower than the fixed rate deals on the market. However, since we are expecting further BoE base rate increases and these products ‘track’ the base rate, the repayments will therefore increase. There is a good deal of risk when selecting a tracker rate and you need to consider if you will be able to afford the monthly payments if the rate increases significantly. Do you have sufficient expendable income or savings in place to cover any shortfall? If your answer is no here, then a tracker rate may not be the best option for you.
On the other hand, if rates are only high for a short period then you could be set to make significant savings when they start to fall. It’s a gamble as to whether this will be the most cost-effective option vs a fixed rate mortgage across a 2-year period (the minimum time you can usually fix in for) but it’s a gamble that could just pay off if you can stomach the interest rate highs alongside the potential lows.
Pros and cons of a tracker mortgage rate:
- Rates are currently lower than a fixed rate mortgage so repayments will currently be less.
- Your rate will fall if the BoE base rate falls.
- Interest rates are predicted to increase further before they come back down, which could mean huge future costs.
- Difficult to budget across a longer period.
Standard Variable Rate Mortgages (SVR)
A lender’s standard variable rate is the product that you will revert to once your current product expires. For the last 10 years, this has been significantly higher than the fixed rate product and so people have been keen to move away from this as quickly as possible. Now, however, in many cases it is lower than the fixed rate a bank is offering and so some borrowers are opting to remain on the SVR.
As the name suggests, the rate is variable but it is set by the lender and is not necessarily linked to the base rate. When the base rate dropped during Covid many lenders did not pass on the saving to their customers so as the rate has increased, a lot of these lenders have absorbed the increase, meaning the SVR has not increased too much. However, if the BoE base rate increases further it is likely the SVR will increase too. On the other hand, you’ll be free to move away from this rate at any time, so if a more attractive deal comes along, you won’t be penalised.
Pros and cons of a standard variable rate mortgage:
- Rates may currently be lower than a fixed rate mortgage so repayments will currently be less.
- You will not be locked into a high-interest deal that fixed term mortgages are now offering.
- If interest rates rise, it’s likely the lender’s SVR will rise too.
- There’s no guarantee your lender will reduce their SVR if the BoE base rate goes down, so you may not get the full benefit of rate changes.
Borrowers have got some difficult times ahead of them but most people will have more than one option available. It’s important to seek advice to determine whether a fixed, tracker or variable rate mortgage is the best solution for you.