To fix or not to fix?

Mortgage borrowers haven’t had to think about the choice between fixed and variable rate loans in recent years, but the decision is now important once again

Should you fix your mortgage interest rate, or go variable? It is a question facing 1.4 million people whose current mortgage deals are due to come to an end in 2023, as well as anyone taking out a new mortgage. The answer partly depends on what you expect to happen to the UK economy over the next few years, but also on your personal financial circumstances and your attitude to risk.

The appeal of a fixed rate mortgage is that you know exactly what your monthly repayments will be for the duration of your deal – typically, fixed rate deals last anywhere between one and 10 years. By contrast, with a variable rate mortgage, there is the potential for your monthly repayments to increase if interest rates go up, or fall if they reduce.

Against that, however, variable rate mortgages have traditionally been priced differently to fixed rate deals. When mortgage lenders expected interest rates to rise over time, their fixed rates were more costly than their variable rates; borrowers had to think about whether they might eventually pay more by opting for the latter. Or, if the expectation was for rate cuts, fixed rates would be cheaper; the calculation for borrowers was whether a variable rate would fall sufficiently for them to save money even though they were paying more to begin with.

In recent years, this debate has largely been a moot point. In the wake of the financial crisis in 2008 and 2009, the Bank of England reduced interest rates to near zero in order to protect the economy. Rates then stayed there for the following decade, and throughout the Covid-19 crisis. With the cost of borrowing so low – and little prospect of much change – variable and fixed rate mortgages were priced almost identically.

For a whole generation of mortgage borrowers, this has meant not having to think too hard about what type of loan to go for. In the last six months, however, that has completely changed. The sharp rise in inflation last year – to a 40-year high of 11.1% in November – prompted the Bank of England to start increasing interest rates. There were eight increases during 2022, taking the base rate from 0.25% at the start of the year to 3.5% by the end.

In 2023, economists expect interest rates to keep rising as the Bank battles to get inflation under control. Following September’s mini-budget, when the financial markets appeared to lose confidence in the UK’s creditworthiness, the expectation was for further significant increases in the base rate – to 6% or more. The Government then changed tack, replacing the Prime Minister and rethinking its budget plans, which has seen expectations moderate; the consensus forecast is that base rates will now peak at a little over 4%.

Nevertheless, mortgage borrowers now face a dilemma. If you’re arranging a two-year deal, say, the cheapest variable rates currently cost around 1 to 1.5 percentage points less than the cheapest fixed rate mortgages. The gap is smaller on longer-term mortgage deals – since lenders expect base rates to begin falling once inflation is in check – but still notable.

At first sight, this means variable rates look like a better deal than fixed rate mortgages in the current environment. Lenders have not yet fully adjusted the cost of their fixed rate deals to reflect the more optimistic outlook today than in the immediate aftermath of the mini-budget. The Bank of England would have to raise interest rates by more than most people expect it to for variable rates to become more expensive than fixed rate deals.

In cash terms, the numbers are significant. Assuming you’re borrowing £150,000 on a repayment mortgage, your monthly repayment would be £841 at an interest rate of 4.58%, one of the cheapest two year fixed available today. Or you could pay £714 a month with a cheap two-year variable rate currently priced at 3.03%. Over two years, that would be a saving of just over £3,000, assuming interest rates stay the same.

Indeed, even if interest rates keep rising, it will be some time before your monthly repayment on the variable deal exceeds what you would have been paying with a fixed rate product. So, rates would have to go up very sharply for you to end up paying more in total over the whole two years of the deal.

Case closed? Not necessarily. If we’ve learned anything in recent months, it is that politics and economics can be volatile and unpredictable. The consensus forecast may currently be for moderate interest rate rises over the year ahead, but that may not prove accurate, particularly if events overtake us. In which case, rates could rise much further and faster, leaving variable rate borrowers out of pocket.

Indeed, for some borrowers, certainty is all-important. If your mortgage repayments account for a significant chunk of your earnings, the comfort that they won’t rise any further may be really important. You may decide it is worth paying a little more each month for the reassurance that there are no nasty surprises to come.

Taking financial advice on your options therefore makes a lot of sense. Everyone’s personal circumstances are different and the mortgage deals on offer are changing by the day. The right mortgage product choice for you may be very different to the best option for someone else.

Your home may be repossessed if you do not keep up repayments on your mortgage.

The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction.

Content is correct at the time of writing and is intended for general information only and should not be construed as advice.

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