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Private Banking -
Is it time to say goodbye to fixed rate mortgages?
Are you coming to the end of a fixed rate mortgage deal? Navigate the UK mortgage landscape with insights on fixed vs tracker rates, interest rate predictions, and strategic decisions.
An estimated 1.6 million fixed rate deals are due to end in 2024, meaning those looking to secure a new mortgage product are facing a challenging decision: What should I do next? This decision is made harder by the current interest rate environment that has risen at an unprecedented pace catching many people by surprise, including mortgage professionals.
In the UK, fixed rate mortgages have steadily increased in popularity since 2016 from around 50% of the market to 86% in Q3 2022[1]. But with the potential end to rate hikes and the possibility of rate reductions in the not-so-distant future, borrowers should be considering their options more carefully than ever before.
Fixed rate products have been the favoured choice in a low interest rate environment, as they offer a comparable rate to their tracker counterparts but with a guaranteed monthly mortgage payment. The latest rhetoric from the Bank of England suggests interest rates may be at or close to their peak, meaning the prospect of interest rates starting to fall should make a tracker rate product a real consideration.
Types of variable rate mortgages and how they work:
- Tracker rate mortgages – usually made up of a margin over the Bank of England’s Bank Rate, the margin remains unchanged for a predetermined period, meaning the interest you pay is determined by the changes in the Bank of England’s Bank Rate.
- Standard variable rate (SVR) or standard mortgage rate (SMR) – most lenders have a SVR or a SMR. These usually fluctuate in relation to the Bank of England’s Bank Rate, but the lender has the freedom to change the rate at their discretion. They are often used as a reversionary rate if you choose not to renew a fixed rate when your mortgage deal expires.
- Discounted rate mortgages – interest rate is set as a discount of the lenders SVR or SMR.
To fix or not to fix?
When deciding what your next mortgage product should be, there are three questions you should be asking yourself:
1 - What are interest rates going to do next?
2 - Can I afford for my monthly mortgage payments to increase?
3 - What are the pros and cons of trackers vs fixed rate mortgages?
1 - What are interest rates going to do next?
With unpredictable moves like 14 consecutive rate rises from the Bank of England and a surprise halt in September, it is difficult to say with certainty what will happen next.
The Bank of England’s chief economist, Huw Pill, commented on 16 October that there is still “work to do” to get inflation under control, adding: “We cannot be complacent…It is important that we do not declare victory prematurely.” This suggests we are unlikely to see any rate reductions in 2023, with the first possible decreases appearing in 2024.
If these market predictions are to be believed this could mean you would start seeing lower mortgage payments as soon as next year. However, these are only predictions, and should inflation remain high it may well mean rates do not fall far from their current highs, and we can never fully discount the possibility they may have to rise again.
2 - Can I afford for my monthly mortgage payments to increase?
Assuming your answer to the first question is ‘I believe interest rates are going to fall’ then your next consideration should be, what if they don’t?
The saying goes, “by failing to prepare, you are preparing to fail”, therefore you need to prepare for the eventuality that rates may not fall or that they could potentially rise. Only you will be able to determine your ability to tolerate rate rises, but there are a plethora of mortgage calculators and budgeting tools available online that could make this exercise a lot easier.
The outcome of this exercise may be that you have no tolerance for interest rate increases, therefore a tracker may not be right for you. Alternatively, you may be able to afford any rate increases and the upside of potential rate reductions remains appealing.
3 - What are the pros and cons of fixed rate vs tracker mortgages?
Fixed rate mortgages
The advantages
• Fixed rates have grown in popularity because they offer peace of mind that your mortgage payments will not change regardless of what the Bank of England’s Bank Rate does.
• This has been very appealing for people grappling with the rapid changes in the cost of living because it means you can accurately budget your future mortgage expenditure.
The disadvantages
• The interest rate will not change for the fixed period – so you will continue paying the same amount regardless of how far the rate falls, when they fall.
• Fixed rates often come with early repayment charges, this means if you are in the fortunate position to be able to reduce or repay your mortgage early, you may be charged for doing so. Also, if you find you have secured a Fixed rate at the peak of the market and the Bank of England’s Bank Rate begins to fall rapidly you will likely be charged a significant fee to buy your way out of the Fixed rate.
Tracked rate products
The advantages
• Tracker rate products allow you to benefit from any decreases in the Bank of England’s Bank Rate, therefore if we have reached the peak and rates begin to fall you will be paying less interest.
• Additionally, typically there are no early repayment charges, so you can overpay or repay a portion of your mortgage without incurring any penalties or fees.
• If interest rates move against you, your lender will often allow you to switch to a different product, such as a fixed rate, penalty free.
The disadvantages
• You must always remember if the Bank of England’s Bank Rate increases so does your interest rate and in turn your mortgage payments.
Conclusion
We may have seen or about to see the peak of Bank of England’s Bank Rate, therefore those looking to take a new mortgage or secure a new product on an existing mortgage are faced with a challenging decision.
However, there are some key questions that you should be asking yourself that should help you decide whether to fix or not to fix?
In summary, fixed rates give you peace of mind that your payments are not going to change but be aware if interest rates start to fall you will miss out, and buying your way out of a fixed rate can be extremely costly.
Fixed rates are often best for those who need or like to budget or those with higher loan-to-values.
Tracker rate products may initially cost the same or more than their fixed rate counterparts but allow you to benefit from any fall in the Bank of England’s Bank Rate. Tracker rate products also often come with the flexibility to switch to a fixed rate penalty free, if required, and the ability to repay or overpay penalty free.
Tracker rate products are often best for those who wish to make over payments and for those who can tolerate the risk of interest rates rising, in return for the reward that if they fall so will their payments.
Further reading
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Author -
James Glover
Head of Regulated Lending
James Glover is Head of Regulated Lending at Arbuthnot Latham. He has thirteen years’ experience in banking and has been at Arbuthnot Latham for seven years.
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