Fixed rate mortgages explained
Fixed rate mortgages can give you the peace of mind of knowing what your repayments will be every month – but they do come with some drawbacks. This page explains how they work and whether they might suit you.
Mortgages largely fall into two main categories: fixed rate and variable. The one you choose will partly determine what you’ll pay each month and overall.
The more you know about mortgages, the easier it is to choose a deal that suits you. So, here’s everything you need to know to get started.
What is a fixed rate mortgage?
A fixed rate mortgage is exactly that: fixed. The interest rate doesn’t rise or fall within an agreed period of time, so you know from the start what you’re going to pay each month.
However, these fixed rates don't last for the entire term of the mortgage. They're often used as introductory offers to attract new customers. When the fixed rate runs out, you're typically moved onto another deal– usually the lender's Standard Variable Rate (SVR), which tends to be more expensive.
Until then, you and your lender are locked in. You can jump out into a different deal if you want to, but you may have to pay an Early Repayment Charge (ERC), which is a penalty for leaving the contract before the end of the initial term. It's charged as a (relatively small) percentage of the mortgage loan. But while the percentage of small, it's still a serious sum of money to find.
If your mortgage has ERCs, they're likely to be highest in the first year and fall which each passing year, so the earlier you leave your mortgage, the higher penalty you're likely to have to pay.
How are these mortgage rates set?
The greater your deposit, the less you'll have to borrow. This gives you a lower ‘Loan to Value (LTV) ratio’ – which is just a fancy term for the percentage of the property's value you're borrowing. If you chip in a 10% deposit, your LTV is 90%. 20% deposit gives you 80% LTV, and so on.
The important bit is: a lower LTV ratio tends to give you a lower mortgage rate.
But rates are also affected by the length of your fixed rate period. A two-year fix with a 75% LTV, for example, could cost half a percent less in interest than a three-year fix.
What else is out there?
Variable and tracker mortgages don't give you fixed monthly payments. The lender can change the amount of your monthly repayment. Tracker mortgages, for example, track the Bank of England base rate. When the base rate rises, your lender reacts, and your repayments can go up.
Interest-only mortgages cost less each month than repayment mortgages because you don't actually pay down the loan, only the interest on the loan. You pay the loan off at the end of the mortgage term instead. It's relatively difficult to get an interest-only mortgage these days, unless it's a buy to let mortgage on a property you're going to rent out.
Are there drawbacks?
It can cost thousands of pounds in ERCs to leave a fixed rate term before it ends, so it's worth giving some serious consideration – especially if you're leaving for a better deal elsewhere and the cost of your ERCs could outweigh the potential savings.
Fixed rate mortgages protect you against rising mortgage rates for a set number of years, but if mortgage rates generally fall you won’t benefit because you’ll continue paying your set monthly bill.
Everyone’s circumstances are different, and so a fixed rate deal might be great for some people but not necessarily you. At Mojo, we can give you a personal mortgage recommendation for free in 15 minutes, making it easier to decide which deal to go for.