My five-year mortgage term is coming to an end and I find myself trying to navigate an increasingly complicated and expensive home loan landscape.
One big change is that all five-year mortgages I’ve seen are now cheaper than two-year deals. My experience so far is that the shorter the term of the mortgage, the cheaper the interest.
Am I going crazy, or are five-year deals cheaper now for some reason? KK, by email
Slowly rising: The cost of all mortgages is rising, but two-year interest rates are rising the most
Sam Barker from This is Money replies: You’re not going crazy – or if you are, it’s not because of the mortgage interest deduction.
Currently, the average two-year fixed mortgage rate is 6.23 percent, while a typical five-year deal costs 5.86 percent, according to financial data company Moneyfacts.
But the trend for five-year deals to cost less is relatively recent, starting in October last year, and has only grown since then.
Historically, shorter term mortgages have come out cheaper as lenders have been more comfortable dropping rates on shorter deals.
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From a lender’s point of view, there was less risk in agreeing on an interest rate for a shorter period of time.
On the other hand, lenders traditionally charged more for longer-term mortgages because the borrower was getting interest for a long period of time.
To answer your question about why this has reversed, we need to delve into the murky world of something called interest rate swap rates.
Swap rates are the interest rates that mortgage lenders pay other lenders for the money they borrow.
This affects fixed-term mortgages, as banks normally ‘buy’ money for terms of two, three, five or ten years.
This is directly related to the price of new fixed-rate mortgages, which are normally two, three, five or 10 years long.
The pricing of these swap rates is determined by banks, who negotiate deals with each other.
Part of these negotiations are predictions about what the economy will look like in the future.
All that bank data is then used by the Bank of England to produce an average called Sonia (the Sterling Overnight Index Average).
Currently, this data shows a strong trend for lenders to raise interest rates on two-year swaps, and therefore mortgages, over other maturities.
Swap rates – the money market rates that lenders use to set fixed-rate mortgage prices – have risen significantly in recent weeks
The reason is uncertainty among lenders due to the current interest rate turmoil.
The Bank of England has raised its base rate 13 times in a row in the face of rapidly rising inflation and is now at 5 percent.
Financial experts believe that the base rate – and thus swap rate – will rise further this year.
Emma-Lou Montgomery, deputy director of personal investing at Fidelity International, said: “A base rate of 6 percent is now being proposed by the end of the year.
“This means mortgage rates are likely to go even higher, and that means more misery for borrowers, homeowners and renters.”
Beyond that point, the markets expect inflation to fall and borrowing to return to normal – which is why lenders charge less for longer-term loans.
But lenders aren’t the only ones betting on falling interest rates, borrowers included.
Despite high rates on two-year mortgages, Moneyfacts says 54.8 percent of homeowners still choose these five-year deals, which are chosen by 27.9 percent.
The reason is that many borrowers want to take the hit of paying a high interest rate for a short period of time, then stick with a – hopefully – lower interest rate when their two-year period is up.
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