Those buying a home or taking out a new mortgage this year are faced with a decision that could save (or cost) them thousands of pounds, depending on whether they make the right choice.
That decision concerns whether they fix their mortgage for two or five years.
Before interest rates rose towards the end of 2022, five-year fixed-rate mortgages proved popular, with around three in five borrowers opting for them.
At the time, mortgage interest rates were relatively low, but rising. That's why it seemed like a good idea to hold the mortgage interest rate as long as possible.
Since then, interest rates have risen dramatically and more and more people are now opting for a two-year fixed rate deal in the hope that they will have fallen by the time they remortgage.
Two-year preference: More than half of Brits opted to fix their mortgage for two years in December, according to Britain's largest online mortgage broker, L&C Mortgages
According to Britain's largest online mortgage broker, L&C Mortgages, more than half of Britons chose to fix their mortgage for two years last month.
This is a far cry from what people did for much of 2022, when about a quarter of borrowers opted for a two-year fixed deal, according to the broker.
This is all the more surprising because a five-year fixed rate is currently usually cheaper than a two-year contract.
According to Moneyfacts, the average two-year mortgage rate is currently 5.93 percent. That compares with 5.54 percent for five-year solutions.
Those with the largest deposits or with larger equity stakes in their homes can also do much better if they fix it for five years, rather than two years.
The lowest two-year solution on the market is offered by Leeds Building Society, which charges 4.6 percent, while the lowest five-year solution is from Generation Home, at 3.94 percent. Both deals come with a £999 fee.
Why this change in fashion?
Many of those who opt for a two-year fixed interest rate period will do so because they think that interest rates will fall in the coming years.
They're essentially banking on the expectation that once inflation subsides, the base rate – and subsequently the mortgage rate – will fall, allowing them to lock in the interest rate at a cheaper rate.
Nicholas Mendes of mortgage broker John Charcol says: 'At current market prices, two-year fixed rates are falling and are certainly more affordable than earlier last year.
'It would be worth considering the short-term pain, rather than being tempted by some of the five-year fixed interest rates currently on offer.
'It is expected that fixed rates will fall even further, so you no longer want to be tied to a higher rate than necessary.
'It may also be worth considering a three-year fix if you want stability for a little longer than two years, but to avoid being stuck for five years.'
Concerns: For homeowners whose fixed-rate mortgages expire in 2024, the prospect of moving to a higher mortgage rate could be a cause for concern
That said, while five-year fixed rates are no longer the product of choice, they were still preferred by around a third of mortgage borrowers last year.
This is because they offer the cheapest rates, as well as certainty about monthly payments for the next five years. This will appeal to some borrowers given how much interest rates have risen over the past 24 months.
On the other hand, fixed-rate deals come with early repayment fees, which can make refinancing a mortgage early a costly affair.
It means that most borrowers are essentially locked in for the next five years and won't be able to benefit if rates fall.
Mark Harris, CEO of mortgage broker SPF Private Clients, says: 'If I were taking out a mortgage this year and my budget was tight, I would opt for a five-year term as it is better to be safe than sorry. Then I could budget for a reasonable period.'
What about tracker mortgages?
Those confident that interest rates will fall faster and further than expected could even try their luck with a tracker mortgage.
Trackers follow the Bank of England's base rate, plus or minus a fixed percentage.
For example, someone can pay the basic rate plus 0.75 percent on top with a tracker. With a base interest rate of 5.25 percent, they would now pay 6 percent.
But if, for example, the base rate were lowered to 4.5 percent, their interest rate would drop to 5.25 percent.
The main advantage of tracker deals is that there are usually no early repayment fees involved.
This means that if mortgage interest rates fall in the coming year, someone with a tracker deal can switch to a cheaper permanent contract at any time.
Take a risk: Those who are confident that interest rates will fall faster and further than expected can even try their luck with a tracker mortgage
On the other hand, if the base rate remains the same or even rises this year, it could be an expensive gamble.
According to L&C, last month almost 10 percent of mortgage providers opted for a tracker mortgage with a term of two years.
In August and September of this year, shortly after mortgage rates peaked, more than 15 percent of borrowers opted for these tracker deals.
“If I could afford to be wrong and deal with interest rate fluctuations, then a basic interest rate tracker with no early repayment fees could be worth considering and keeping a close eye on the market,” Harris adds to.
'If the fixed rates go down, you can switch to a new rate without penalty.
'As always, it's worth using an agent who covers the whole market to ensure you get the right advice and deal for your circumstances.'
Will mortgage rates fall in 2024?
Over the past two years, the Bank of England has increased the base interest rate from 0.1 percent to 5.25 percent.
But now attention has shifted to when the Bank of England could start making cuts.
Richard Harrison, head of mortgages at Atom Bank, said: 'While Andrew Bailey has warned against premature consideration of rate cuts, the reality is that future interest rate expectations will significantly impact mortgage prices.
'Rates have already fallen noticeably in recent weeks. Barring any unforeseen developments, this trend is likely to continue next year, resulting in more competitive rates across the board.”
According to financial market bets, the Bank of England will cut interest rates six times in 2024, taking rates from 5.25 percent today to 3.75 percent by Christmas in 15 years.
That would be a major incentive for borrowers who need to take out a new mortgage and for first-time buyers on the housing market.
However, mortgage rates will still be much higher than before rates started rising in late 2021.
> When will interest rates fall? Predictions about when the base interest rate will fall
John Charcol's Mendes thinks the cheapest five-year fixed rate could fall below 3.5 percent in the second half of the year.
'January is a new start, but it is also crucial for lenders to lay the foundation for a successful year. Lenders are wasting no time this time and starting the price war earlier, which has certainly surprised a number of people, including myself.
'At the start of the year, more lenders should release five-year fixed rates below 4.5 per cent, with more best buys below 4 per cent.
'We will also see the two- and three-year fixed interest rate fall to below 4.5 percent.
“From spring until mid-2024, market expectations will be for a deal below 3.75 percent as markets continue to price in a cut in bank rates in the coming years.
'Depending on inflation rates and the broader economic and political landscape, we could see in the second half of this year that the five-year fixed rate will be the first to yield below 3.5 percent, while the two-year and three-year fixed rates will be the first will be the first to see an interest rate below 3.5 percent. interest rates then break the benchmark of 4 percent.'
Falling: Interest rates have already fallen noticeably and, barring any unforeseen developments, this trend is likely to continue next year, according to analysts
However, not all brokers are convinced that interest rates will fall so sharply.
Mark Harris, chief executive of mortgage broker SPF Private Clients, said: 'Fixed rate mortgages will be lower than base rates at a time when interest rates are forecast to fall.
'We are currently seeing this with lenders reducing their fixed-rate mortgages, a trend that we expect to continue in 2024.
'The market generally agrees that the base interest rate will fall, the question is when and at what pace.
'We would suggest that the Bank of England will cut the base rate around May or June, with rates likely to be somewhere between 4 and 4.5 percent by the end of this year.'
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