Introduction
Fixed rate mortgages guarantee a specific rate of interest for a set length of time.
Most commonly, this is for between one and five years, though it can be as long
as ten, fifteen or even 20 years.
As a rule, the longer the fixed period, the higher the rate of interest will be.
A lender will not want to commit to lending you money at a really low interest rate
for ten years, when there is a fair chance that during that period the general level
of interest rates may rise above the rate at which they are lending you money. Therefore,
among fixed rate deals, the lowest interest rates are usually to be found with deals
that are fixed for one, two or three years.
It is also possible to find stepped fixed rate mortgages, where the interest rate
is, for example, fixed at one level for one year and then a slightly higher level
for two further years.
Advantages
One of the best things about fixed rate mortgages is that they provide you with
certainty in an uncertain world. Whatever happens to the economy and irrespective
of any changes in the Bank of England base rate or the lender's own SVR, the interest
rate payable on your mortgage will stay the same during the fixed period. This makes
it much easier to budget for the costs of home ownership with a fixed rate mortgage
than it is with any other type of rate, as you can be sure that your repayments
will stay the same for a certain period of time.
A good time to buy a fixed rate mortgage is often when the base rate is at a historically
low level, or when there is a strong possibility that the Bank of England Monetary
Policy Committee (MPC) will raise the level of interest rates at some point in the
not too distant future. Your repayments would be protected against any increase
in lending rates that followed a base rate rise - something that would not be the
case had you opted for a discounted rate mortgage.
Disadvantages
Although fixed rate mortgages give you security that your repayments will not rise,
this peace of mind usually comes at a slight cost, in that fixed rate mortgages
are often offered with marginally less competitive rates that an equivalent discounted
rate mortgage.
Furthermore, you could potentially be locking your repayments at a needlessly high
level were interest rates to fall during the fixed period. Take the year 2001 for
example. During the course of the year, the MPC made 7 cuts to the base rate, a
pattern that was mimicked by the majority of lenders with repeated cuts in their
lending rates. Any mortgage customers who fixed their rate of interest at the start
of 2001 will have missed out on these successive reductions and are probably still
paying a rate of interest that is considerably higher than that which is available
to new borrowers.
Of course, customers that are stuck paying an uncompetitive fixed rate of interest
could always switch to another product or remortgage with a different lender. But
another feature of fixed rate mortgages is that they normally tie the borrower into
the deal with expensive early redemption penalties that become payable should the
customer wish to change mortgages within the fixed period.
This is understandable and acceptable to most people, as long as the redemption
penalties are only payable for the duration of the fixed period. However, some of
the most competitive fixed rate mortgages have a redemption penalty overhang. This
is where the redemption penalty continues beyond the fixed rate period, effectively
tying you in for a longer period. At the end of the fixed period, the rate of interest
payable will revert to the lender's Standard Variable Rate, which is usually much
higher than that rate you were previously paying
A final point that you need to be aware of, which is a feature of all mortgage rates
that come with some form of introductory offer, is the possibility of an interest
rate shock at the end of the fixed rate period. This is simply where your mortgage
repayments jump upwards from one month to the next due to the higher rate of interest
payable on your loan after the end of the introductory period. With a fixed rate
mortgage, this phenomenon can be made all the more difficult financially if the
base rate and subsequently the lender's SVR have climbed during the fixed period,
making the hike in repayments all the more severe.