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Is A Five-Year Fix Playing Too Safe?

The next few years look set to be interesting ones for the UK.  On the plus side, COVID19 does seem to be abating.  On the minus side, it’s leaving its financial (and social) toll behind.  Then there’s Brexit.  There’s also a general election in 2024.  Against that backdrop, a five-year fixed-rate mortgage can provide welcome stability.  That stability, however, comes at a price.

Fixed-rate versus tracker mortgages

Fixed-rate mortgages guarantee the borrower a certain interest rate for a certain time. Tracker mortgages, by contrast, track the base rate set by the Bank of England. In principle, fixed-rate mortgages carry a risk for both the borrower and the lender. If interest rates drop, borrowers will pay more than they would otherwise have done. If they increase, lenders lose out.

In practice, however, for the moment at least, the risk is very much with the lender. Even though the Bank of England recently increased the base rate, it is still just 0.5%. This means that there’s a lot more scope for interest rates to go up than for them to go down. For the time being at least, there is a lot more reason for them to do so.

The reason the Bank of England raised interest rates in the first place was to try to bring down inflation. They are tasked with keeping this at 2% (with a +/-1% margin of error). What happens next, therefore, depends on the direction of inflation. Realistically, this may ease during the warmer months. It is, however, likely to increase again during the colder ones.

Mortgage lenders are perfectly well aware of all of this. They will therefore price that risk into the cost of their fixed-rate products to protect themselves. This means that, potentially, borrowers could end up paying a lot more for fixed-rate mortgages than for tracker ones.

The price of security

The longer a borrower fixes their rate for, the more at risk the lender is. This means that longer fixes have a higher “security premium” than shorter ones. With that said, by definition, they also provide security for longer. This means that buyers have to figure out for themselves, how much security they are willing to pay for.

Borrowers who opt for shorter fixes (one or two years) can expect to get better rates than those who opt for longer fixes. They will, however, need to go through the hassle and cost of remortgaging after a relatively short time. They may also find that their repayments jump significantly at the end of their initial mortgage term.

What’s more, if the housing market flatlines or has a downturn, borrowers may find that they have little to no equity. In fact, they may even find themselves in negative equity. This does not have to be a catastrophe. As long as borrowers can keep paying their mortgages, they can ride out downturns. It can, however, make it impossible to remortgage until the issue is resolved.

This means that there is a strong argument in favour of somewhat longer fixes. Realistically, however, for the average person a three- or four-year fix may work out a lot more cost-effective than a five-year (or longer) fix. It gives the borrower a bit of extra breathing space to build up equity. At the same time, it limits the lender's risk, hence allowing for better rates.

The golden rule of mortgages

Regardless of whether you choose fixed-rate or tracker, short-term deal or long-term deal, you must ensure that you have a new deal ready and waiting when your old one comes to a close. If you don’t, you will end up on your lender’s “Standard Variable Rate” (SVR). This can be very expensive. If you have concerns about remortgaging, then a mortgage broker may be able to help.

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