Should I choose a fixed or variable rate mortgage, as rates start to fall?

When mortgage rates skyrocketed late last year in the wake of then-Prime Minister Liz Truss’ mini-budget, homebuyers and re-mortgators were left with a difficult situation.

Many were forced to choose between a new fixed term with a much higher interest rate than they were used to, or taking a chance on a slightly cheaper variable mortgage and waiting for rates to drop before locking in.

On Sept. 22, the day before then-Chancellor Kwasi Kwarteng’s ill-fated mini-budget, the best rate for a two-year fixed mortgage with a 25 percent down payment was 4.06 percent, according to data from Defaqto. At the beginning of October that was 5.69 percent.

On a £200,000 mortgage, this increased payments by £198 per month, or £2,268 per year.

For years, fixed rate deals were the obvious choice for most homeowners because they were much less expensive than variable rate mortgages, such as trackers and standard variable rates.

But as rates rose, the gap between fixed and variable rates narrowed and in some cases reversed, creating an incentive to switch to a variable rate until fixed prices fell.

> Borrowers can check the latest rates on both variable and fixed deals using This is Money and L&C’s mortgage calculator

What is a variable rate mortgage?

With a fixed mortgage, the borrower agrees on a rate and pays it for the first term – normally two or five years. Floating rates, on the other hand, move depending on the Bank of England base rate or a lender’s own standard floating rate (SVR).

Unlike a flat rate, you can’t be sure what your mortgage payment will be each month.

There are three types of variable mortgages. The first is a tracker mortgage that follows the Bank of England’s base rate, with a fixed percentage on top. For example, you might see a mortgage advertised as “Basic +0.75 percent for two years.”

At the beginning of December 2021, the Bank’s base rate stood at 0.1 percent. The base rate is now at 4.5 percent after a series of increases to cope with rising inflation.

The second type is standard variable rate mortgages. Here the lender sets their own rate and can change it whenever they want. While the decision to raise an SVR can be influenced by a rise in base rates, the two are not directly linked.

Linked to SVRs are discount mortgages, also known as discounted variable rates. These have an interest rate that is a certain amount below the lender’s SVR, meaning it fluctuates when the SVR moves – so you may be offered a “0.96 percent discount for two years.”

While they don’t move as fast as trackers, lenders will generally pass on any increases in their own borrowing costs to borrowers, driving the rate up.

With most lenders, you can convert an SVR rate to one of their fixed-rate products at any time without penalty. It means that borrowers may be able to switch to a fixed deal once the rates on their variable deal increase.

Trackers and rebate rates, while cheaper than SVRs, are more likely to incur early redemption penalties – so it’s important to check the terms before stepping away from your current deal.

How much can a flat rate save?

The current five-year average fixed mortgage rate is 4.97 percent, according to the latest data from Moneyfacts. In contrast, the average SVR rate is around 7.37 percent. It is a difference of 2.4 percentage points.

The difference between the SVR and the average two-year interest rate is 2.11 percentage points.

Those who have large deposit mortgages could benefit even more, as rates are likely to be lower than those averages.

For someone with a 25 percent down payment, Halifax is currently offering a five-year fixed deal at 4.06 percent. The closest variable rate is Newbury Building Society, which offers 4.24 percent on a five-year discount rate.

With the average mortgage debt in the UK over £257,000, homeowners coming to the end of a fixed rate mortgage could soon pay hundreds of pounds more per month if they use a lender’s average SVR rate.

However, Compare the Market has calculated that switching to a variable rate can save as much as £401 per month. With an SVR at the Moneyfacts average rate, the monthly cost is £1,790, based on an average mortgage debt of £257,815 per household over a 30-year term. This drops to £1,379 for the same mortgage size on the average five-year fixed rate agreement.

According to the Office for National Statistics, more than 1.4 million households with fixed-rate mortgages will be extended by 2023.

Is it the right time to move to a flat rate deal?

Justin Moy, general manager at EHF Mortgages, says the appeal of variable rate mortgages has diminished in recent months as the products have become more expensive than comparable short-term, fixed-term contracts.

“For smaller mortgages, the potential benefits of using an SVR are small and probably not worth it, while those with larger mortgages still find the potential base rate cuts worth it,” he says.

“We may have a little more to do with tariffs before we see wholesale reductions.”

But it’s important to remember that no one option is right for every borrower and it’s worth talking to an advisor about what would work best for you.

Alex Hasty, director of Compare the Market, said: ‘We understand that this is an uncertain and difficult time for many homeowners as SVR and fixed-term interest rates are still significantly higher than a year ago.

“Those coming to the end of a fixed-rate deal soon will likely face a major redemption shock, even if they plan to move to a new fixed-rate deal.

Chris Sykes, senior mortgage advisor at broker Private Finance, says: ‘It’s rare that we ever recommend a client to insist on their lender’s SVR, so if they are on it, it’s critical that they explore their options.

This option doesn’t necessarily mean opting for a fixed rate – although many borrowers now are, as these often have a lower rate than trackers or variable rates at the moment. But it’s definitely worth getting off the SVR anyway.’

Gary Bush, Financial Adviser at MortgageShop.com, added: “Our advice to customers is to take a reduced rate now with no redemption penalty if necessary and take into account all the costs of potentially re-mortgaging at a later date to another lender once rates improve.

“Or take a fixed rate for two years now, which will allow you to escape to the market at that stage and potentially reap the benefits of a better fixed rate market.”