Interest rates
Fixed Rate Mortgages
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.
