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The pros and cons of fixed-rate mortgages

POSTED: 5th August 2014
IN: Personal Guides
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Buying a house is likely to be the biggest financial commitment you will make in your life, so it is extremely important to think about the different mortgage products on offer and which option is best suited to your situation.

Buying a house is likely to be the biggest financial commitment you will make in your life, so it is extremely important to think about the different mortgage products on offer and which option is best suited to your situation.undefined

One decision - arguably the biggest one - is whether to fix your interest rate for a set period or opt for a variable rate.

When making this choice, make sure you assess each alternative carefully and consider which is best for you, with regards to your personal needs, plans and financial arrangements.

Read on to find out more about fixed-rate mortgages and their various advantages and drawbacks.

How fixed-rate mortgages work

The concept of the fixed-rate mortgage is essentially a very simple one - the interest you pay on your borrowing is set at a certain rate for the duration of your deal. This means your repayments stay the same for the agreed time, regardless of what happens to the Bank of England's (BoE) base rate of interest.

Lenders usually offer to fix rates for periods of two, three or five years, during which time borrowers are assured that their mortgage payments will stay the same. After this time, the interest you pay will revert to the standard variable rate offered by your lender.

The main alternatives to fixed-rate mortgages are variable and discount rate products, which are sometimes linked to the BoE base rate. This means if the central bank rate goes up or down, so will your personal interest rate and your monthly repayments.

What is the current situation with fixed-rate deals?

With an increase in the BoE base rate seemingly on the horizon, it is inevitable that mortgage lenders will be making upward adjustments to their own rates.

In a recent report, Moneyfacts.co.uk pointed out that the combination of a low base rate and the launch of the Funding for Lending scheme resulted in mortgage rates being at a record low for the past few years.

Research showed that the cost of fixed-rate mortgages, particularly the most popular two-year deals, is 'creeping up'. In the two-year, 60 per cent to 80 per cent loan-to-value tiers, the lowest rates available from lenders have jumped in the last month, following three months of historically low interest.

However, this does not seem to be putting borrowers off fixed-rate products, particularly those remortgaging their properties.

Research by the Mortgage Advice Bureau found that 93 per cent of remortgage borrowers chose to fix their rates in June 2014, up from 88 per cent in the previous month.

According to data collected by Moneyfacts, 95 per cent of homebuyers, and 89 per cent of people remortgaging, chose to fix their interest rate between January and May this year.

Brian Murphy, head of lending at the Mortgage Advice Bureau, said: "Fixed rates have been the majority preference under the 0.5 per cent base rate but as speculation grows over the timing of a future rate rise, they are fast becoming the default option whether you are buying or remortgaging."

He acknowledged that lenders have introduced gradual interest rate rises since the start of the year, but stressed that "exceptionally good" rates are still available and mortgage providers are eager to lend.

"More people are keen to lock down their rates for longer before the Bank of England makes a change," added Mr Murphy.

So what are the advantages of fixed-rate mortgages?

If you are thinking of switching or signing up to a fixed-rate mortgage, the main advantage you can look forward to is absolute certainty about how much you will be paying every month over the term of the deal.

Regardless of what happens to the base interest rate, even if the BoE decides to implement a succession of sharp hikes before the end of the year (which is extremely unlikely), you will have peace of mind that your rate will stay the same.

This is particularly appealing for people who are trying to budget and get their finances in order. Many consumers are currently striving to save money and protect themselves against the sort of financial hardships we have seen over recent years, and having a clear idea of your monthly outgoings is crucial to achieving this.

And the disadvantages?

The fact that your mortgage has a fixed rate of interest can go both ways - you are protected if the BoE base rate goes up, but you will not see the benefit should the rate go down, as someone on a tracker mortgage would.

Before deciding which option to choose, do some research on interest rates and how they could change in the near future. At the moment, the base rate is only likely to go one way - up. Consequently, fixed rates are proving popular among borrowers who want to shield themselves against higher costs, but at times when the BoE rate is likely to fall, tracker mortgages will interest people who want to turn the trend to their advantage.

You should also bear in mind that, once the fixed-rate period comes to an end, your mortgage will return to a variable rate. Wider interest rates may have increased during the term of your deal, leading to the phenomenon known as 'payment shock', where the borrower has to adjust to a potentially large increase in monthly repayments.

Another important consideration is whether a fixed-rate deal will be the best option for you in the long run. When factors such as arrangement fees and the rate you will pay after the incentive period has finished are taken into account, you could find a variable rate deal works out cheaper.

You should also give some thought to any unexpected costs that could arise, such as the penalty fee you might have to pay if you don't see your deal through to the end.

There are many factors to consider, but it is important to give close thought to the finer points of any mortgage proposition you are considering, to guarantee it is the right choice for you.

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