What is a fixed-rate mortgage?
With a fixed-rate mortgage you are charged interest by your lender at a set rate for an agreed period.
For example you may get a deal charged at 3% interest for three years. In the UK the majority of fixed rates available have initial terms of between two and five years although lenders may offer fixed rates for anything from one to 25 years.
No matter what happens to wider interest rates, your mortgage payment is fixed for that period. This means you will know exactly what your monthly repayments are for the period of time you agreed to. They will not go up or down. At the end of the fixed period, you will either revert to your lender’s Reversionary Rate or you can choose to remortgage to another deal, for example another fixed rate.
What is a variable rate?
Alternatively, a variable-rate mortgage moves up and down in line with wider interest rates, so your rate of interest and therefore your monthly repayments can change. This means that you do not have certainty about your repayments because they have the potential to increase or decrease.
Some people do not mind this, especially as it is possible that your mortgage repayment may reduce if rates go down. In addition, some variable rates can be very low indeed, such as discounted variable rates or discounted trackers.
Borrowers with flexibility in their monthly budget, to allow for any possible rate rises, may prefer to take out a variable-rate mortgage.
Advantages of a fixed rate
The biggest advantage of a fixed rate is that you know exactly what your repayments will be for a pre-agreed length of time. This gives you peace of mind when it comes to budgeting, because your mortgage repayments are set in stone. This protection against interest rate rises is essential to some borrowers, for example first-time buyers who don’t have a lot of leeway in their budget, and cannot afford to be hit with an increase in monthly repayments.
While fixed rates offer borrowers invaluable security by locking your rate, there are downsides. If the bank base rate falls your mortgage payment will remain the same for the fixed period you have entered into. If you decide to switch or pay off your mortgage during your initial fixed period (for example because you need to move house or sell up), you could be charged. Fixed rates usually come with costs called 'early repayment charges,' which are basically penalties for leaving the mortgage before the end of your agreed period.
The charges can be expensive, ranging from one to five per cent of your outstanding balance, so they can easily run to thousands of pounds. Because of this, longer-term fixed rates are best suited to borrowers who expect to remain in their property and their mortgage for the duration of the deal.