High interest rates and the speculation that they will soon fall pose quite a puzzle for borrowers. Here’s how to settle the debate over a two-year versus five-year fixed-rate mortgage
Are you hesitating between taking out a two-year fixed-rate mortgage or a five-year fixed-rate mortgage? Then you have come to the right place.
This is a question that many potential buyers and refinancing homeowners are pondering right now, and it’s no wonder.
As I’m sure you know, it’s a bit of a mystery.
Here’s the problem. A two-year solution is more expensive. New Moneyfacts data published this week shows that the average two-year fixed rate is 5.91%, while the five-year version is 5.48%. The cost difference in refunds for the two can amount to hundreds of euros.
But while you’ll pay more to lock in the rate for two years, and it’s forecast that rates could fall later this year, the cheaper five-year option would then limit you for the long term and prevent you from having to pay even lower rates in the future. interest rates can you benefit from?
We asked some questions to two experts: Gemma Bennetta senior mortgage broker at The Mortgage Mum and David Hollingworth, associate director of communications at L&C Mortgages – to help you get to the bottom of the puzzle.
Two-year fixed interest rate – the pros and cons
As we’ve found, two-year fixes are currently more expensive. But Hollingworth explained that this was not what you would normally expect. In the past, people even paid more for the security of a five-year home.
Today, with interest rates expected to fall, things are a little different.
“Currently you would have to pay a higher rate, even though you get a more limited protection period,” Hollingworth explains.
“Since fixed interest rates generally tie the borrower in for the fixed rate period, the potential benefit of two-year deals is that after the first two years you have the opportunity to reprice without any penalty.
“If rates have been reduced during that time, this could potentially provide an opportunity to switch to a new, cheaper rate.”
The said penalties, also known as Early Repayment Charges (ERCs), are worth considering, even if you sign a two-year contract. The penalty charged generally decreases with each year of mortgage maturity.
Bennett explained: “If you decide to end your two-year fixed rate sooner than two years, your ERCs will likely be lower compared to the five-year fixed rate because of the time remaining.”
Five-year fixed interest rate – the pros and cons
With a five-year fix you pay less and have what Bennett describes as ‘budget security in a turbulent market’.
“The downside,” she added, “is that you won’t benefit from the expected declines in interest rates until after the five-year period.
“If rates drop significantly, you can do some calculations to see if switching early and taking the ERCs into account is still more beneficial, but ultimately you will have to pay a penalty for doing so.”
How do you choose the right option for you?
Basing your decision on which mortgage to choose simply based on what might happen to interest rates is a bit like placing a bet.
Hollingworth said there are plenty of customers looking for a two-year solution and taking the hit of higher costs in the hope that they can take advantage of better rates in two years.
“Of course,” he said, “that may not happen, so borrowers could fool themselves for not taking the longer-term security of a five-year rate, or worse, rates could even be higher than they are today.
“Those who simply prefer to know where they stand may prefer the security of a five-year interest rate and feel like two years will fly by.”
So also look at your own situation: your plans, goals and practice.
Hollingworth added: “No one can know exactly what will happen to interest rates, so it is best for borrowers to think about what is most important to them, rather than trying to guess what will happen to interest rates. to happen.”
Think about your own future plans (not just those of the Bank of England). Both of our experts advised you to think about whether you can move within five years, for example. Is there any chance you’ll want to refinance? home improvements? This is all worth taking into account.
What are the alternatives to two- or five-year solutions?
There are many more product options than just the regular or two- and five-year garden repairs.
Hollingworth said: “Lenders offer a wide variety of fixed deals and an intermediate three-year rate could tip the scales for some.
“There are now also lenders who offer options that fix the interest rate for ten years or even for the life of the mortgage. This removes all concerns about rising and falling interest rates and should ensure that the mortgage remains affordable.
“The downside could be that interest rates would be reduced, but lenders are aware that this can be a hurdle and some may resolve this for life but only lock the borrower in for a shorter period, or offer the chance to mortgage under certain circumstances without penalty. .”
There are also variable mortgages, including trackers, which go up and down according to the Bank of England’s base rate.
You will be offered an interest rate on a tracker mortgage of, for example, 1.5% plus the base interest rate. With the basic interest rate currently 5.25% borrowers would pay 6.75% on this deal.
Bennett said: “These are generally higher than current fixed rates. However, they will obviously fall (and rise) with the Bank of England’s base rate or the lenders’ variable rates.
“Forecasts suggest that interest rates will fall in the future and that is one of the benefits: many (but not all) of these do not have ERCs and that allows for more flexibility in the future.”
She added: “These types of products require careful consideration and proper advice.”
If you take out a new mortgage, one option is to return to your lender’s standard variable rate (SVR). This is the standard interest rate that you use if you do not switch to a new mortgage agreement.
Some people may use this as a stopgap while they see what happens with rates. However, according to Moneyfactscompare.co.uk, the average SVR is currently 8.18%, which means hefty refunds. Please contact a broker if you are considering this option as they may have other cheaper solutions.
Still undecided: here’s what to do…
So what if you’re still unsure? Bennett said you really dig deeper into your budget and future plans. “Don’t try to ‘play’ the market, but be authentic to your personal priorities and needs,” she added.
“A mortgage lifespan has many ups and downs, both of which you will experience over the years. Try to understand that as normal and choose you.”
Meanwhile, Hollingworth said for those ending a fixed mortgage deal, the worst thing you can do is nothing.
“This,” he said, “will likely send borrowers to a high standard variable rate.
“If borrowers really believe that rates will fall soon, a penalty-free tracker could at least give them the flexibility to make a move at the right time for them.”
He added: “It is also important to consider the cost of switching to a tracker and then another switch to a fix, which can also incur costs.
“Stay focused on what works best for you and give you the right level of protection or peace of mind to match your attitude to interest rate risk – ultimately no one knows what will happen to interest rates!”