One of the key things to consider when deciding on a mortgage is whether to go for a variable or fixed rate mortgage – which is usually between 2 and 5 years.
Let’s look at the pros and cons of each in turn.
Fixed Rate Mortgage
A fixed rate mortgage is a mortgage with an interest rate that stays the same for a set period of time – usually between two and five years. Because the interest rate is fixed, your monthly mortgage repayment will stay the same for the duration of the term. When the fixed rate expires, you are automatically switched to a variable rate. This is usually your lender’s standard variable rate (SVR).
The best thing about a fixed rate mortgage is the security and stability that comes with knowing exactly how much you are going to be paying in the coming months and years. This makes it predictable and easier to budget for – hence is a good idea if you run a tight ship from a budgeting point of view.
On top of this, the interest is paid on the sum outstanding, so you pay the most interest at the beginning of the mortgage. By locking the interest rate for between 3 and 5 years, a fixed rate could mean huge savings.
On the flipside, if the interest rate goes down, you still end up paying the same amount and could potentially spend more than you would otherwise have with a non-fixed rate mortgage.
Fixed rate mortgages also tend to lack the flexibility you may find with other mortgages and tend to have steep exit fees, atleast during the fixed term period to deter people from switching during this time.
Also, when the fixed term ends, you would be put on the variable rate which will typically be higher than the fixed deal you were on as a result of which your monthly payments could go up.
Variable Rate Mortgage
A variable rate mortgage is quite the opposite – the interest rate and consequently the monthly mortgage repayment can fluctuate at any point throughout the term of the mortgage.
There are typically two main types of a variable interest rate – the standard variable rate or a tracker rate.The standard variable rate (or the SVR) is fixed by the lender , who can increase or decrease it at any point. A tracker rate on the other hand, falls the movements of another interest rate, usually the Bank of England’s base rate.
The main advantage of a variable rate mortgage is the possibility that you will end up with a low rate and a low monthly repayment. Because you are taking on the risk that the interest rates could go up in the future, the lender rewards you with a lower rate, at least initially.
On the downside, the interest rates can increase dramatically, which means your monthly repayments could increase drastically to the point of becoming unaffordable.
To sum it up, whether to go for a fixed or a variable rate depends on your circumstances and your overall attitude to risk. If you are worried about the stability of your finances or are simply the kind of person who wants to know exactly how much you will be paying for your mortgage each month, then a fixed rate mortgage is the best option for you. On the other hand if you have more leeway in terms of how much you can afford to pay for your mortgage each month, then a variable rate may be the right option for you.