How long should you fix your mortgage?

The Monetary Policy Committee meets on Thursday to decide whether or not to raise interest rates, and those wanting to protect themselves from potentially higher mortgage payments in the future may be wondering how long to lock into a fixed rate for.

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Of course, no-one knows whether the Bank of England base rate will rise on Thursday or not, but one thing is certain, and that’s that the next move will be up.

As a result, many homeowners and those looking to buy are keen to switch to fixed rate deals, so that they won’t be crippled by steeper mortgage payments as rates rise.

But deciding how long to fix for can be difficult, and this week, Leeds Building Society made the decision even trickier by introducing the option of a new 10-year fixed rate deal – the only one of its kind available to those with a 20% deposit.  The lender’s new offering is payable at a rate of 5.99% and comes with set-up fees of £999.

Kim Rebecchi, spokesperson for Leeds, said: “This product delivers peace of mind and security over a large part of a typical mortgage life, and at an affordable rate.  We expect it to prove extremely popular with borrowers who want to guarantee their mortgage payments for the long term.”

Fixed rates versus flexibility

Security always comes at a price – and borrowers will need to weigh up if it’s worth paying. First off, if you do decide to lock into the Leeds 10-year fix, you will be subject to early repayment charges (ERCs) if you redeem the deal at any time within its decade timeframe.

These penalties kick off at a hefty 6% of the outstanding mortgage for the first two years, tapering down to 5% in years three to six,  4% in years seven and eight, 3% in year nine and 2% in year 10. Borrowers can however ‘port’ the mortgage to a new home during the decade penalty-free, and are also permitted to make up to 10% overpayments without being hit in the pocket.

Nevertheless, this is a long time to be anchored down to one mortgage deal, says David Hollingworth at broker, London & Country:  “The issue surrounding long-term fixed rates remains the trade-off between long-term security and locking in for such a long period. Most borrowers like the idea of knowing where they stand but may not be as keen to be tied in by ERCs for a 10-year period.”

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Longer fixes, higher rates…

And, as the longer you fix in for, the more it will cost you, the shackles seem tighter still. The rate of 5.99% suddenly appears very uncompetitive when put next to the shorter-term fixes available. 

For example, the cheapest two-year fix on the market (for borrowers with a slightly bigger deposit of 25%) is from Yorkshire Building Society and priced at just 2.99%. On a typical £200,000 repayment mortgage taken over 25 years, this works out £340 a month cheaper than Leeds’ 10-year fix. But the rub lies with the fact that this saving, of course, is only guaranteed for the first two years.

Similarly, the best five-year fix on the market, though with a deposit of 30% of the property value, is from Nationwide Building Society and priced at 4.39%, with a £999 fee. This equates to a difference of £188 per month compared to the Leeds deal – but again the saving is only guaranteed for the first five years.

Looking ahead

The key question for borrowers then, is what is going to happen to the cost of fixed rates? Not even the experts can be certain of this, but borrowers can at least do their homework.

Fixed rate mortgages are priced on swap rates which move in anticipation of the Bank of England base rate – and, as mentioned earlier, it’s widely agreed this is set to rise.  The Consumer Prices Index (CPI) measure of inflation soared to 4.4% in February – way ahead of the government’s 2% target – which is putting increasing pressure on the Bank to hike rates sooner rather than later.

The effect of this situation on fixed rate mortgage deals is already evident. According to figures from moneysupermarket.com, the average two-year fix was priced at 4.52% in mid-March, compared to 4.34% just five months ago in mid-October.

Nevertheless, a fixed rate premium could be worth paying in return for the peace of mind that you will be able meet your monthly mortgage repayments, regardless of what happens to interest rates going forward.

And, according to a report published this week by the Bank of England on UK credit conditions, this peace of mind is becoming increasingly valuable. The report found that the number of people defaulting on their mortgage has jumped ‘unexpectedly’ since the start of the year – and that this figure is expected to increase as interest rates and the cost of living climb.

A good fit, not a gamble

The length you choose to fix in your mortgage for should therefore hinge on the level of shelter you need, rather than an attempt to ‘outwit’ the mortgage market. Kevin Mountford, head of banking at moneysupermarket.com said: “Homeowners on a budget who simply cannot take a gamble on what happens to mortgage rates, and who are relatively ‘settled’ and looking for security of payments for the long-term, should at least consider the 10-year fixed rate options available.”

But unfortunately, these borrowers will be met with limited choice. The only current competitor to Leeds’ 5.99% 10-year fix is from Yorkshire Building Society. The lender is offering a rate of 5.49% for 10 years in exchange for a 25% deposit and £995 fee.

Please note: Any rates or deals mentioned in this article were available at the time of writing.

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