If you’re a first-time buyer or a remortgager this guide explains what fixed interest rates are and how a predicted rise in rates could affect you.
Interest rates remain remarkably low, for now.
The Financial Times reports that the BoE (The Bank of England) have signaled ‘modest tightening’ of their monetary policy in the next 2 years, suggesting that interest rates won’t remain at 0.1% for long.
Could now be a good time for first-time buyers and remortgagers to lock in low rates and if so, how long for?
We answer all this and more in this guide. Here’s what’s covered:
The central bank’s Monetary Policy Committee (MPC) met on the 4th of August 2021 and decided that economic conditions had been met to allow it to start discussing raising interest rates in the future. However, out of the 8 members, 7 voted to keep rates at 0.1% for now.
Andrew Bailey, the BoE governor, thinks that the period of inflation is temporary but noted that the MPC takes the risk of persistently higher inflation very seriously.
That being said, the BoE’s forecasts showed only very gradual interest rate rises were likely to be necessary to keep inflation close to its medium-term target of 2%.
A fixed interest rate mortgage is charged with an unchanging rate for a fixed period of time.
Interest is what’s charged on your mortgage, so securing a deal with low interest means that you pay less money for your loan.
Having a fixed interest rate can be a good thing if you have a mortgage because it means that you know exactly how much your repayments are for a given time period. If rates are low, like they are now, it also means that you can lock in a good interest rate, before they increase.
Interest on a fixed-rate mortgage doesn’t stay fixed forever though because each agreement has a fixed interest rate period. Once the fixed-rate period ends, the lender charges its standard variable rate, which is usually higher.
A fixed interest rate mortgage lender agrees to provide a mortgage and charge a specified rate of interest, for a given time period. During that period, the rate of interest never changes. To understand how a fixed interest rate mortgage works, it can be helpful to know how interest rates are set and why they go up and down.
UK lenders use the central Bank of England’s base rate to set their own rates. The base rate is what they’re charged to borrow from the central bank.
Lenders, like mortgage lenders or credit card companies, charge interest on top of this when providing finance because they take on the risk that you might not repay it.
If you take out a fixed interest rate mortgage and lock in a low rate, you take away the lender’s ability to charge you more interest, in the event that the base rate changes and they’re charged more to borrow from the BoE.
So, if interest rates rise, your repayments remain unchanged, while people with a mortgage that has a variable interest rate, such as a tracker or discount mortgage, pay more.
That is of course until your fixed-rate period ends and it reverts to the lender’s standard variable rate (SVR).
If you don’t remortgage before your fixed-rate period ends, either with the same lender on a different deal or a new lender completely, you’ll have to pay your lender’s standard variable rate.
These rates are usually a lot higher, which is why securing a fixed rate for a longer period of time can be a good thing.
For example, say the base rate is 0.1% and your chosen mortgage lender charges an additional 2% on top of that for their mortgage product. Hypothetically, you could secure that 2,1% rate for 2 years on a 25-year mortgage for £100,000.
That means for 2 years, your mortgage repayments never change, costing you £429 per month.
After those two years, your fixed interest period would end and you’d be transferred to your lender’s standard variable rate. For this example, the SVR rises to 4% and as a result, your mortgage repayments would increase to £528.
An increase of interest means you’re being charged a bigger amount to borrow, so the increased interest payments wouldn’t reduce the capital of your mortgage, i.e. the amount you borrowed.
Usually, mortgage lenders offer fixed-rate periods ranging between 1-5 years, though a handful of UK mortgage lenders may be willing to provide a fixed-rate mortgage for up to 15 years.
Keep in mind that mortgage products with long fixed rates may only be offered to borrowers who present a very low risk of defaulting on their mortgage and therefore, you will need to meet eligibility criteria which may require you to have no or low bad credit, a good credit score and/or a larger deposit.
While securing an interest rate for a long period of time can be helpful to borrowers who want to benefit from the predictability of their repayments, usually, the longer the fixed-rate period, the higher the interest rate and the tighter the lending restrictions.
Shorter fixed-rate mortgages can offer you more flexibility to hop from different mortgage providers in order to seek out the cheapest deals. Remortgaging can cost money though and without a broker, it can feel like a hassle.
That’s why some people either have an appointed broker to manage their mortgage over the years or they find a fixed interest rate mortgage with a longer fixed period so their repayments stay the same for a longer block of time and therefore, they don’t have to shop around over the years.
Not always, however, mortgages that have a longer fixed-rate period can be more expensive overall because you (the borrower) avoid any change to your repayments in the event that interest rates increase or decrease.
This security can come at a cost and as a general rule of thumb, the longer the fixed-rate period, the higher the interest.
Fixed interest rate period in years | Fixed interest charged | Mortgage repayments for £100,000 based on a 25-year term | The standard variable rate charged once the fixed period ends | Mortgage repayments for £100,000 based on a 25-year term |
1 | 3% | £474 | 4% | £528 |
2 | 3.1% | £479 | 4% | £528 |
3 | 3.2% | £485 | 4% | £528 |
4 | 3.3% | £490 | 4% | £528 |
5 | 3.4% | £495 | 4% | £528 |
The above example assumes that a standard variable rate is higher than a fixed interest rate but remember, a variable rate can go up and down.
If you don’t remortgage once your fixed-rate period ends and you start paying your lender’s SVR, it will likely be higher and you run the risk that rates will increase further and you’ll pay even more.
However, because that rate won’t be fixed and will follow the BoE base rate, you could also benefit from a decrease in rates as your monthly repayments would go down.
Using the same example as above, if the SVR were to fall to 2%, your monthly repayments could decrease to £424.
Staying on your lender’s SVR might not always cost you more but it does leave you open to the risk of rates going up and you suddenly having to pay more. This uncertainty is what makes many people opt for a fixed rate.
The figures in the table above are purely given as an example and are not representative of current mortgage products. Rates vary massively between lenders, so for specific rates based on your unique circumstances, speak to a mortgage broker.
They’ll have access to a network of lenders and can quickly navigate through them to find you the very best fixed interest rates based on your circumstances.
Once your broker knows exactly what your ambitions are for homeownership and what level of flexibility you require in your contract, they can look specifically for those lenders and present you with an accurate cost rather than you base your decision on estimations.
That’s what makes a broker’s advice so invaluable.
Unfortunately, some lenders charge high upfront costs or larger early repayment charges to compensate for the low rates.
High early repayment fees could prevent you from making overpayments on your mortgage because the cost of the fee can sometimes outweigh any financial gain made from reducing your overall loan size.
While the initial savings made by securing a low-interest rate can be advantageous, always calculate that against any fees that are associated with the agreement.
Don’t get caught out by a lender offering a competitive fixed-rate mortgage only to be stung with high fees.
Mortgage lenders should always clearly outline any fees that may be charged during the process of getting a mortgage or during the actual agreement and these may be referred to as:
Yes, there are mortgage lenders in the UK that provide fixed-rate mortgages to first-time buyers and if you’re eligible for one of these products, it may be worth considering locking in a low rate before they are predicted to rise in 2022.
Predictions are just that though, predictions. So always bear in mind that while you may secure a low rate now to avoid a nasty hike in the near future, interest rates may stay as they are or decrease. No economist can predict the future, so weigh up all the factors that could affect how much you pay for your mortgage, as well as the conditions for which you have to repay.
2021 has seen house prices rise by up to 10% in some areas and while that’s not good news for first-time buyers on a budget, there are new and improved schemes like Shared Ownership and the First Homes Programme that can help to reduce the cost of homeownership.
If you’re keen to get a house this year and take advantage of low-interest rates before they might rise, check your eligibility for a wide range of fixed-rate mortgages with a broker and get the ball rolling.
Find out if you’re eligible in a couple of clicks, with no hidden credit checks.
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