Fixed rate mortgages: Ultimate guide to how they work
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Fixed rate mortgages are the most popular mortgage product for UK homeowners.
Apart from anything else, they offer borrowers certainty, because for however long your fixed rate period lasts, you know exactly what you’d be paying each month.
They can also be great value, often beating variable rate mortgages.
But fixed rate mortgages aren’t always the best option for everyone.
It can depend on your financial situation, future plans and what you expect interest rates to do in future.
What is a fixed rate mortgage?
In its most basic form, a fixed rate mortgage is one where the interest rate is fixed for a specific length of time.
This period is often known as the initial period, fixed period, or introductory period.
The most widely available fixes are two, three and increasingly five years but you can also find fixes for one year, 10 years and sometimes even longer.
During that fixed rate period, the interest rate on your mortgage – and therefore the amount of money you pay each month – remains the same regardless of what’s happening in the economy.
So if you’ve managed to get a fixed rate mortgage while interest rates are low, and the Bank of England subsequently puts up the Bank Rate, you’d still be paying your initial rate for the duration of the fix.
It’s important to note that the fixed rate doesn’t last for the full term of the mortgage, only that initial period.
After the initial period ends, you move on to what’s known as the lender’s standard variable rate (SVR), which is often significantly higher.
It’s why homeowners typically choose to remortgage shortly before they move onto the SVR to keep their costs down.
If you’re confused about all the different terms, my mortgage glossary might help.
Aside from the interest rate, fixed rate mortgages have a couple of distinguishing features that may make them unsuitable or undesirable for some borrowers.
Arrangement fees
Fixed rate mortgages often have arrangement fees attached.
These can range from a couple of hundred pounds to a couple of thousand, depending on the value of your mortgage.
This of course increases the overall cost of your mortgage and is something you’ll need to factor in when working out which mortgage offers you the best deal.
Early repayment charge
During the fixed rate period, you can typically overpay up to 10% of the value of your mortgage each year.
This overpayment is on top of your monthly payments and can help reduce the amount of interest you pay overall.
However, paying more than your annual overpayment allowance will incur additional fees, which are typically billed as an early repayment charge (ERC).
Similarly, if you want to pay off your mortgage early, there will be an early repayment charge to pay.
The ERC is designed to cover the lender’s loss in interest income when you pay back your mortgage early.
The amount that’s charged is affected by factors such as how much you’re repaying, the size of your mortgage and how long you’re into your fix.
How fixed rate mortgages work in the UK
Like any other mortgage, the lender will assess your financial position to determine your eligibility and whether the mortgage product you’re applying for is affordable for you.
This includes your income and outgoings, credit history and the size of the deposit or equity you hold.
If they are happy to lend to you, they will offer you a fixed rate deal based on the loan to value ratio (LTV) of your home as well as a number of other factors such as the Bank of England Bank Rate and their assessment of your financial standing.
The more deposit or higher equity you hold, and the better your financial standing, the lower your fixed rate will be.
How long should you fix your mortgage?
If you’ve decided on a fixed rate mortgage, the second question you’ll be thinking about is how long to fix your mortgage for.
The answer to this question can depend on both your situation and the state of the economy.
A shorter fix gives you more flexibility, which is helpful if you think you might move in the next few years or you feel interest rates will fall.
A longer fix will be better if you know you’re staying put or if you expect interest rates to go up in the near future.
You also have to factor in those aforementioned arrangement fees, which can make shorter fixes less attractive in the long run.
I personally prefer a longer fix and I think lifestyle factors should be more important than the state of the economy.
As a self employed freelancer, I want stability and the ability to budget properly because I know what I’ll be repaying each month over a longer period of time.
I also save time by not having to seek out new deals every few years.
After all, you go through eligibility checks with every remortgage, which means you might not be offered a better deal further down the line, especially if your circumstances have changed.
Read this: How to choose your mortgage
What happens when your fixed rate mortgage ends?
The interest rate on your mortgage is only applicable during the fixed period. After that, you automatically move onto the lender’s SVR.
You have a couple of options here.
You can stay on the SVR, which might be worth doing if you’re close to paying off your mortgage or if you’re expecting to pay a lump sum on your mortgage in the near future.
I personally moved onto the SVR after my fixed rate ended because I was close to paying my mortgage off.
If you’re on the SVR for any longer than six months, it’s worth considering the alternatives.
In this case, you can either remortgage or look for a new deal with your existing lender or look elsewhere.
If you know you want to remortgage, you can start looking for new deals about six months before your fixed period comes to an end.
Remortgaging can take a couple of months to process so it’s definitely worth keeping an eye out for what’s available before you commit.
As for moving to a different lender or staying put, it can depend on your circumstances.
Staying with your current lender often means less paperwork and faster approval but you might be able unlock better rates by moving.
Just don’t forget to factor in the arrangement fee when you make your decision.
Can you leave a fixed rate mortgage early?
If your current fixed rate mortgage is no longer working for you, you can leave it early.
However, the lender will apply an ERC, which can run into the thousands.
If interest rates have crashed and you’re on a high fixed rate mortgage, it might be worth leaving your current deal early to capture those extra savings – but you’ll need to work out whether it is still a saving after all the fees.
If you’ve come into an inheritance or have won the lottery, and want to pay a chunk of your mortgage off, it might actually be more cost effective to wait until your fix comes to an end.
And if you’re simply moving home, it’s worth checking whether you could port your mortgage instead.
Are fixed rate mortgages worth it when interest rates are high?
When interest rates are volatile, most people don’t want to fix their mortgage for long periods of time.
Afterall, what if interest rates fall after a year and you’ve fixed your rate for five years?
If you’re serious about savings, it’s worth going back and crunching the numbers to see what might work out best for you.
But even if you’ve got the numbers refined like a mathematical model, you might still guess wrong.
What’s more useful, like I mentioned earlier, is to consider your own personal circumstances.
Are you likely to lose your job or otherwise experience an impact on your income? If so, getting a longer fix will help with budgeting and financial stability.
Do you think you might move abroad or sell your home soon? In that case a short fix will give you a bit more flexibility.
Any gains from interest fluctuations would just be a bonus.
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