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Should you take out a fixed or a variable rate mortgage?

Andre Spiteri
6 August 2019

We discuss the differences between fixed and variable interest rate mortgages and their pros and cons.

One of the biggest decisions you face when choosing a mortgage is whether you should go for a fixed or variable rate. On the one hand, it’s hard to argue with the certainty and stability of a fixed rate. But then again, no-one wants to give more money to their mortgage lender than they really have to. Right?

So what’s one to do?

Here’s a look at the differences between fixed and variable rate mortgages and some pointers to help you decide which one’s best for you.

What is a 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 to 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 term expires, you’re automatically switched to a variable rate. This is usually either your lender’s standard variable rate (SVR) or a tracker rate.

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What are the pros and cons of fixed rate mortgages?

The best thing about fixed rate mortgages is that your interest rate - and therefore your monthly repayment - stays the same throughout the agreed term. As a result, it’s easier to budget for your monthly expenses and stay on top of your finances. This means it could be a good idea if you have a tight monthly budget.

Besides, interest is calculated on the sum outstanding, so you pay most interest at the beginning of the mortgage. By locking in the interest rate for between 3 and 5 years, a fixed rate could mean huge savings.

By contrast, the interest and monthly repayment on a variable mortgage could change from Day 1, which makes it a bit of a gamble. It could work out much cheaper than a fixed rate mortgage, but it could also turn out to be really expensive.

The flipside is that, if interest rates go down, your interest rate still stays the same. Consequently, there’s a risk you could pay more in interest than you would on a variable rate mortgage.

Fixed rate mortgages also lack the flexibility you might find with other mortgages. They tend to have steep exit fees, at least during the fixed term period. This might act as a deterrent for anyone thinking of changing mortgage.

Finally, once the fixed rate term expires, you’re put on a variable rate. This tends to be higher than the fixed rate. And, because you’ll pay more interest your monthly mortgage repayment might go up.

What is a variable rate mortgage?

A variable rate mortgage is the opposite of a fixed rate mortgage. The interest rate - and, consequently, your monthly mortgage repayment - can fluctuate at any point throughout the term of the mortgage.

There are two main types of variable interest rate: the standard variable rate or a tracker rate.

The standard variable rate is fixed by your lender, who can increase or decrease it at any point. Most lenders tweak their standard variable rate to reflect changes in the Bank of England’s base rate. However, they may change it even though the Bank of England’s base rate is unchanged.

A tracker rate follows the movements of another interest rate, usually the Bank of England’s base rate. So, if the base rate goes down, the tracker rate goes down too and vice versa. However, the tracker rate is usually higher than the rate being tracked. By way of example, a tracker rate could be the Bank of England’s base rate plus 2%.

What are the pros and cons of a variable rate mortgage?

The main advantage of a variable rate mortgage is the possibility that you’ll end up with a low rate and a low monthly repayment. As a plus, because you’re taking on the risk that the interest rate might rise in the future, your lender will reward you with a lower rate, at least initially.

On the downside, interest rates may rise dramatically, which means your monthly repayments could increase drastically or even become unaffordable. In theory, interest rates are influenced by supply and demand. The higher the demand for credit, the higher interest rates will be and vice versa. However, this is only a small part of the picture; and it’s hard to predict their behaviour with 100% accuracy.

Should you choose a fixed or variable rate mortgage?

There’s no right or wrong answer to this question. It really depends on your personal circumstances and your overall attitude to risk.

If you’re worried about the stability of your financial situation, you’re inexperienced or you’re simply the type of person who’d rather know exactly how much they’re in for each month, a fixed rate mortgage could be the better option for you.

With that being said, a fixed rate mortgage is still somewhat of a gamble. Interest rates might go lower, which means you could end up paying more interest than you would've had you opted for a variable rate mortgage.

The Bank of England’s base rate is currently at record lows. So, with this in mind, and provided you’re financially stable and comfortable with the risk that rates might rise, a variable rate mortgage may be the better option.

Of course, it’s hard to predict what will happen in the future with 100% certainty. A mortgage is a long-term commitment, and just because variable rates are low today doesn’t mean they’ll still be at these levels 10 or even 5 years down the line.

Helpful hint
The interest rate shouldn’t be your only consideration when choosing a mortgage. You should also look out for the fees and, importantly, carefully check the terms and conditions. A fixed rate mortgage will change to a variable rate after the introductory period expires. It’s good to at least leave the door open to the possibility of remortgaging, so try opting for a lender that doesn’t make this too difficult.

In a nutshell:
  • The interest rate of a fixed rate mortgage stays the same for a set period of time, after which it’ll switch to your lender’s SVR or to a tracker rate.

  • Fixed rate mortgages keep your mortgage repayments predictable and stable. However, you could pay a lot more interest than you would with a variable rate mortgage.

  • The interest rate of a variable rate mortgage can fluctuate, which affects your monthly mortgage repayment.

  • Interest rates are currently at all time lows. However, the situation might change in the future, which means there’s a risk your monthly repayment could become unaffordable.

  • Your choice of mortgage is a question of personal preference. Don’t just base your decision on the interest rate, but also on other factors such as fees and terms and conditions. Try to keep remortgaging a viable option in case your circumstances change.

by Andre Spiteri

Andre is a former lawyer turned financial writer. Andre has written this article especially for ClearScore.

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