Are you torn between taking out a two-year fixed rate mortgage or a five year fix? If so, you have come to the right place.
This is a question which many-a would-be buyer and remortgaging homeowner is pondering at the moment and it’s no wonder.
As you will no doubt be aware – it’s a bit of a conundrum.
Here’s the problem. A two-year fix is more expensive – new data out just this week from Moneyfacts shows the average two-year fixed rate is 5.91% whilst the five-year version is 5.48%. The cost difference in repayments for the two can amount to hundreds of pounds.
But whilst you will pay more to fix for two years, with predictions interest rates might fall later this year, would the cheaper five-year option confine you for the long haul, and prevent you benefiting from even lower rates in the future?
We put some questions to two experts – Gemma Bennett, a senior mortgage broker at The Mortgage Mum and David Hollingworth, associate director of communications at L&C Mortgages – to help you get to the bottom of the puzzle.
Two-year fixed rates – the pros and cons
As we’ve established – two year fixes are currently more expensive. But Hollingworth explained this was not what you’d normally expect to see. In fact, in the past people paid more for the security of a five-year shelter.
These days, with the expectations interest rates will fall, things are a little different.
“You would currently have to pay a higher rate despite getting a more limited period of protection,” Hollingworth explained.
“As fixed rates will generally tie the borrower in during the fixed rate period the potential upside of two-year deals is that you have the chance to review without any penalty after the initial two years.
“If rates have reduced in that time it could potentially open up a chance to switch to a new, cheaper rate.”
The penalties mentioned, also known as early repayment charges (ERCs), are worth considering even if you take out a two-year deal. The penalty charged tends to reduce with each year the mortgage passes.
Bennett explained: “If you decided to exit your two-year fixed rate earlier than two years your ERCs are likely to be lower when to compared to the five-year fixed rate due to the amount of time left.”
Five-year fixed rates – the pros and cons
With a five-year fix you pay less and have what Bennett describes as ‘budget certainty in a turbulent market’.
“The downside,” she added, “is you’ll not benefit from expected rate drops until after the five-year period.
“If rates drop significantly you can do some calculations to see if switching early, and factoring in the ERCs, is still more beneficial but you’ll ultimately have a penalty charge to pay for doing so.”
How to choose the right option for you?
Basing your decision on which mortgage to choose simply on what might happen to interest rates alone is a bit like placing a bet.
Hollingworth said there were plenty of customers plumping for two-year fixes and taking the hit of the higher cost in the hope they will be able to take advantage of better rates in two-years’ time.
“Of course,” he said, “that may not happen so could leave borrowers kicking themselves that they didn’t take the longer term surety of a five-year rate, or even worse rates could even be higher than they are today.
“Those that would just prefer to know where they stand may well prefer the security of a five-year rate and feel that two years will fly by.”
So, look at your own situation too – your plans, goals and the practicalities.
Hollingworth added: “No one can know exactly what will happen with interest rates so it’s best for borrowers to think about what is most important to them rather than try to second guess what will happen to interest rates.”
Think about your own future plans (not just those of the Bank of England). Both our experts suggested you consider whether you might move, for example, within five years. Is there a chance you may wish to refinance to make home improvements? This is all worth taking into account.
What are the alternatives to two or five-year fixes?
There are many more product options than just the common or garden two- and five-year fixes.
Hollingworth said: “Lenders offer a real variety of fixed deals and an intermediate three-year rate could strike the balance for some.
“There are also lenders now offering options that fix the rate for 10 years or even for the life of the mortgage. That would remove any worry about the ups and downs of interest rates and should ensure that the mortgage will remain affordable.
“The downside could be if rates were to ease back but lenders are aware that can be a hurdle and some may fix for life but only lock the borrower in for a shorter period, or offer the chance to repay the mortgage without penalty in certain circumstances.”
There are also variable mortgages including trackers, which go up and down according to the Bank of England base rate.
On a tracker mortgage you will be offered a rate – for example 1.5% – plus the base rate. With the base rate currently at 5.25% borrowers would pay 6.75% on this deal.
Bennett said: “These are generally higher than the fixed rates at the moment. However they will naturally fall (and rise) with either the Bank of England base rate or the lenders variable rate.
“Predictions suggest rates are going down in the future and there lies one of the benefits, also many – but not all – of these have no ERC’s and that allows for more flexibility going forwards.”
She added: “These types of products should be carefully considered and well advised.”
Indeed, if you are remortgaging one option is to revert to your lenders’ standard variable rate (SVR) which is the rate you default to if you don’t switch into a new mortgage deal.
Some people can use this as stopgap whilst they see what happens to rates. However, the average SVR is currently 8.18% according to Moneyfactscompare.co.uk so will mean hefty repayments. Speak to a broker if you are considering this option as they may have some other less expensive solutions.
Still undecided – here’s what to do…
So, what if you are still unsure? Bennett said really drill down on your budget and future plans. “Don’t try to ‘play’ the market, but be authentic to your personal priorities and needs,” she added.
“A mortgage life span sees many ups and downs, you’ll experience both over the years. Try to understand that as normal and choose for you.”
Meanwhile, Hollingworth said for those exiting a fixed mortgage deal, the worst thing you can do is nothing.
“This” he said, “is likely to see borrowers fall onto a high standard variable rate.
“If borrowers are really convinced that rates will come down soon then a penalty-free tracker could at least give them the flexibility to make a move at the right time for them.”
He added: “It’s also important to consider fees to switch to a tracker and then another switch to a fix which could also incur cost.
“Keep focused on what will work best for you and give you the right level of protection or peace of mind that suits your attitude to interest rate risk – ultimately no one knows what will happen to rates!”
