What’s a fixed-rate mortgage

What are the benefits of a fixed rate mortgage? The lender agrees to give you a short-term special rate. Regardless of what happens to interest rates, with a fixed mortgage your repayments are fixed for the length of the deal.

Lenders call this the incentive period – and all fixed deals will have one, whether it’s two, three, five, 10 or 15 years. Sometimes it’s even possible to find fixed-rate deals that last for the life of your mortgage.

Like all mortgage deals, fixed rates have pros and cons:

• Certainty – you know exactly what your mortgage will cost.
• Your payments won’t go up over the life of the fix, no matter how high rates go.
• You’ll know EXACTLY what you’ll pay, meaning you can budget around it.

• If interest rates fall, you won’t see your payments drop.
• If you want to get out early, you’ll usually pay high penalties.

If a fixed mortgage sounds good, think carefully about how long you want to fix for. Ideally, you don’t want to leave the deal before the initial period ends, as there’s usually an early repayment charge, which can add significantly to your costs.

What is a variable rate mortgage?

Here your mortgage rate, as the name suggests, can and will usually move up and down. The major, but not sole cause of this, is changes to the UK economy.

In times of growth and inflation, interest rates tend to go up to discourage spending (as is happening right now). This is to make saving more attractive and borrowing costlier – meaning people are less likely to borrow to spend. In downturns, interest rates are often cut to encourage spending.

To complicate things, variable rate deals fall into three categories: trackers, standard variable rates (SVRs) and discounts. This is how they work:

Tracker mortgages

Here, the rate tracks a fixed economic indicator the bank base rate, the Bank of England’s official borrowing rate. This doesn’t mean it’s the same as the base rate, just that it moves in line with it.

Tracker mortgages are popular in times of low or falling interest rates (which isn’t the case right now). Here are the pros and cons:

• It’s transparent as you’ve the certainty that only economic change can move your rate, rather than the commercial considerations of the lender.
• Flexibility, ability to make overpayments or switch products generally without penalty.

• Uncertainty – if rates rise, so will yours.
• You’re also locked into a fixed relationship, so if you’re paying a rate several percentage points above the base rate and interest rates jump, it could mean huge future costs.

Tracker mortgage rates usually track above the base rate. For example, a tracker mortgage might track at the base rate (currently 2.25%) plus 1%, so that would be 3.25%. Currently, the best tracker mortgage rates you’ll find are around the 3% mark. However, if the base rate was to increase by one percentage point, so would your mortgage.