Variable rate mortgages are growing in popularity as buyers worry about being locked in to high fixed rates – but it’s an option that comes with risks, explains Kay Hill
For the past six years, first time buyers have overwhelmingly voted in favour of fixed rate mortgages as they offer absolute certainty about monthly payments for a fixed period of time. Figures from UK Finance show that nine out of 10 first time buyers from 2017 to 2021 chose fixed rate mortgages, with the figure increasing to 96% from 2019.
In the first quarter of 2023, however, UK Finance noted that the number of new variable rate mortgages was the highest in a decade – at 13% of new mortgages. And an increasing number of would be homeowners have been asking First Time Buyer whether they should be considering taking out a variable rate mortgage, where the amount due each month can change if the lender’s interest rate goes up or down.
Are Mortgage Rates High?
In December 2021, the average five year mortgage had an interest rate of 1.59%, which makes this autumn’s average rate for a five year fix of 5.49% seem incredibly steep. But today’s figures are very similar to the decade leading up to 2008 – in reality, it is the long period of very low interest rates from 2008 to 2021 that was unusual. And, let’s not forget that in 1990 buyers were paying around 15% on their mortgages!
Expert Comment
Every pound usually counts for first time buyers, and right now the average rate available on two year tracker rate deals is lower than on two year fixed rate mortgages. Anyone with an eye on mortgage rates may also have noticed that fixed rates have been falling in recent months. As a whole, this may lead to the temptation to opt for a lower tracker rate now and hope that fixed rates carry on dropping for you to lock into at some point in the future. However, the huge risk is that no one knows for certain what will happen to mortgage rates going forward. If you take out a tracker mortgage, which typically follows movements in the Bank of England base rate, there is always the possibility that your interest rate could go up, which would increase your monthly repayments as a result. If your budget is tight, this may not be a risk that you can afford to take. There are also no guarantees that the cost of fixed rate mortgages will continue to fall, and that they won’t rise, either. Ultimately, you should look for a mortgage that suits your circumstances overall, which is why talking to a mortgage broker is usually worth considering.
Tim Leonard, Personal Finance Expert, NerdWallet
Will Rates Go Up or Down?
This, of course, is the vital question, but even at First Time Buyer we don’t have a crystal ball. There are some encouraging signs, however, that rates may have peaked.
- Inflation has gone down from 11.1% in October 2022 to 6.7% in September 2023, meaning that the Bank of England’s strategy of raising interest rates to cut inflation appears to have worked.
- The Bank’s Monetary Policy Committee decided by a majority of 6 to 3 not to raise interest on the Bank Rate from 5.25 in November.
- Mortgage companies are beginning to cautiously lower rates and price competition is building to attract new customers.
- Five year fixes are currently cheaper than two year fixes, which suggests that the lenders are expecting rates to go down slightly in that time.
However, even the most optimistic experts are not predicting that rates will be dropping back to 2% in the next couple of years. There is also the chance of something unpredictable – another war or disastrous Budget, for example – that could suddenly change everything.
Key Difference Between Fixed and Variable
When interest rates go up, they only affect those on a fixed rate mortgage when the fixed rate period comes to an end, giving time to prepare for any increases. However, if interest rates fall during the course of the fixed term, borrowers won’t see any benefit, with early repayment charges meaning it is usually too costly to end a fixed rate mortgage early.
Those on a variable rate mortgage will be affected by interest rate changes much sooner – straight away with a tracker mortgage that’s directly linked to the official bank base rate, or within days or weeks for those on a discounted variable rate that is linked to a lender’s own standard variable rate (SVR). Lenders aren’t obliged to change their SVR with the base rate but usually do so shortly afterwards.
Weighing the Risks
“Ultimately, the decision to fix a mortgage rate or not comes down to personal preference,” says Alice Haine, Personal Finance Analyst at Bestinvest. “A fixed rate mortgage offers certainty, as the repayment on the mortgage remains the same for the full duration of the deal. This is ideal for people who like to budget, as they can plan their finances around the mortgage as they know exactly what they must repay. Someone who can only just afford their repayments would be unwise to take the risk on a variable deal. A borrower with spare cash above their mortgage repayment, however, could be less risk averse and gamble on rates holding or falling in the future, which could work out cheaper over the long term.”
Even those who decide to fix have a tricky decision to make – while longer fixes are currently cheaper than shorter fixes, and lock in a stable price for longer, they also increase the risks of paying over the odds if rates do drop. “Over a five year period, rates could edge down further, meaning borrowers miss out on better deals with early repayment penalties to pay if you want to exit a fixed product early,” says Alice. “Instead, a two or three year fix may be preferable for those who see mortgage rates dropping further in the next few years. That way they can then seek out a better deal in 24 or 36 months rather than waiting the full five years.”
Don’t Forget Fees
However, it’s also worth noting that product fees and charges can seriously skew calculations; if you have decided on a fixed rate mortgage, you could find that paying two lots of high fees for two short term fixes rather than a single fee on a five year fix can quickly lose any savings you might make from a small reduction in interest rates (not to mention causing considerable stress and paperwork).
Equally, if you decide to choose a variable rate mortgage so you have the flexibility to move on to a fixed rate deal if prices come down, it’s important to pick one with low fees and charges. Beware of product fees at the start, early redemption charges and lock in periods, high property valuation fees and exit charges. Some lenders offer a low headline mortgage rate but make up for it with lots of fees and charges, which can quickly make it very expensive if you want to change lender. With so much to consider, Alice advises, “A good independent mortgage broker can offer guidance on the best scenario for each buyer’s situation.”
Expert Comment
To fix or not to fix? This isn’t the question you should be asking. Try these instead: What can I afford? And how resilient are my finances? After a very turbulent year, it’s understandable that first time buyers may feel torn between two apparently unattractive options. Should you lock in a longer term fixed rate substantially higher than it would’ve been a few years ago or try out a variable or short term fixed option in hopes rates fall over the next few years? There are a few things to consider. If you’re ready to buy but know you’d struggle if rates increase further like they did earlier this year, and you value certainty in your monthly expenses, don’t gamble – lock in a fixed rate. However, if you could afford to pay those higher rates over an extended period of time until lower rates came in, you could consider variable options. But lower rates are not a guarantee – and very few people believe 2% rates will return any time soon. The best thing you can do is seek expert, tailored advice. Being able to afford your mortgage should never be a gamble that may or may not pay off – it should be rooted in what you need to prosper in your own home.“
Pete Dockar, Chief Commercial Officer, Gen H
First Time Buyer is an exciting bi-monthly glossy which takes a stylish and comprehensive look at all the options available, setting them out in an entertaining and informative way, and helping potential customers navigate their way through what is often a daunting and complex process. We dispel the myths, reinforce the facts and arm the reader with the tools necessary to make their homeownership dreams a reality.
