Staggeringly high inflation rates over the last few months has forced the Bank of England to increase Bank Rate almost every month.
It means that interest rates on savings as well as mortgages are steadily going up.
Given there’s so much uncertainty around, I thought it might be an interesting time to look at whether you should go for a short or long mortgage term and the cost implications.
It will be especially relevant for those who may need to renew their mortgage in the next year or so, or are thinking about getting a mortgage for the very first time.
Two mortgage lengths to consider
There are two different lengths you need to think about when choosing your mortgage.
The first is the mortgage term – this means the total length of time that you’ll be paying back your mortgage.
Typically for a first mortgage, one that’s less than 20 years is considered a short term one while one that’s 30 years or more would be considered a long term one.
The second length is specifically for fixed rate mortgages, where you have an introductory period during which the interest rate is fixed. After this, a standard variable rate (SVR) applies.
Is a long or short mortgage term better?
Long mortgages have the benefit of being more affordable month on month but you may end up paying back more money overall.
Shorter mortgages, meanwhile, have a high monthly cost, but the overall amount you pay back could be lower.
In the past, the typical length of a mortgage in the UK was around 25 years, although this has gone up in the last few years.
It’s been a mixture of availability – more mortgage products lasting 30 or even 40 years are coming on the market – and affordability, as homes become too expensive to finance on a shorter mortgage.
To a certain extent, the length of the mortgage you can get is out of your hands.
Lenders are unlikely to offer a mortgage that runs into your retirement, which means if you get a mortgage later in life, you might be forced to choose a shorter term than you’d like.
And if you’re ambitiously going for a short term mortgage, your application might be rejected if the lender decides that you don’t meet the affordability criteria.
How to choose the best mortgage length
You should start by working out what you can afford.
The government’s Money Helper website has a simple (adjustable) calculator that you can use to see how much you might expect to pay back each month depending on the amount you borrow, the mortgage term and the interest rate.
Then you just add up all your other regular expenses (bills, taxes, food etc) to see how much you’ll have left from your salary at the end of each month.
If you have more than 50% of your income left over, it’s a pretty good sign that you can afford to pay a bit more each month so a shorter term might work for you.
But for due diligence, you should also stress test your affordability. What if the interest rate went up by 5% for example – can you still afford your mortgage then?
Once you’ve worked out what’s affordable, decide what works best for your circumstances.
If you have a steady job and/or are in a double-income household, choosing the shortest affordable mortgage term would make the most financial sense.
Although of course you might want to have more money left over because you want to go on lavish holidays or save up for an extension – or if kids or pets are on the horizon.
If you’re a single-income household or your income fluctuates (for example self employed or seasonal workers), it might be more prudent to go for a longer mortgage term so you have more flexibility over what you do with that extra cash.
You can always make overpayments on your mortgage to reduce its length and therefore the overall amount of money you pay back.
Fixed rate mortgages vs variable rate mortgages
There are two main types of mortgages: variable rate and fixed rate mortgages.
Variable rate mortgages track the movement of the Bank of England Bank Rate, which can go up as well as down.
These were popular when interest rates were high, because there’s a chance that the rate could drop and you would be able to cash in on the savings.
When interest rates all but crashed to the floor in the early days of the pandemic, most of these were withdrawn.
Fixed rate mortgages, meanwhile, have an introductory period where the interest rate you pay is relatively low.
After the initial “fixed” period, the rate you pay rises to the lender’s SVR, which tracks a couple of percentage points above the Bank of England Bank Rate.
At this point, most people will remortgage to move onto a new introductory rate, which can be higher or lower depending on what’s available in the market at the time.
Note that for smaller sums, you might not be able to secure a new mortgage and may have to remain with your current lender.
How long should you fix your mortgage?
Last summer turned out to be a great time to apply for a fixed rate mortgage – the rates were low and there was plenty of choice.
Arguably, though rates have risen significantly, it’s still worth locking your rate in now as it’s almost certain that rates will continue to rise in the foreseeable future, even if the Bank of England doesn’t hike Bank Rate again.
You’ll benefit from a period where you know exactly how much you’ll pay towards your mortgage each month, which will be useful for budgeting given the cost of living crisis.
The problem is, how long to fix it for.
You have a choice of two, three, five or even 10 year fixes available at the moment and you’ll likely pay a fixed fee on top for all of these options.
Two and three year fixes have the lowest interest rates, which can work out cheaper overall. They also give you more freedom if you think you might want to move home soon.
A five or 10 year fix will give you longer peace of mind, and more time to plan and prepare, but it might also end up costing you more because you’ll pay a higher rate for those benefits.
Sadly there’s no obvious answer to this one – you’ll have to crunch the numbers to see how much you would expect to pay overall in each case and balance it with what your plans might be further down the line.
My take on fixing mortgages
My personal preference is for a longer fix because most mortgages have a fee attached, which you have to pay on top of the sum you’re borrowing.
On a shorter fix, the amount of money you save in interest repayment might not outweigh the fee.
As a freelancer, I also like the stability that comes with knowing exactly how much I’ll pay off each month.
Over a longer period, I’ll have more time to build up savings for a buffer and repayment once my fixed period is up.
What’s more, I think it’ll take significantly longer than two years for the economy to rebalance, and for interest rates and inflation to settle.
That means in two years’ time, the choices available will almost certainly be worse.
Three years wouldn’t be objectionable if the circumstances were right for you.
For example, if you’re expecting a huge pay rise soon and can afford to repay more, or are planning to move home, you won’t have to wait for long to make changes.
Ten years I think would be too long for most people, unless it’s your forever home.