What’s the difference between a fixed and variable mortgage?
Mortgage interest can be charged in two ways: through a fixed rate, where the interest rate remains stable, or a variable rate, where the interest rate can change over time.
When you take out a mortgage, one of the big considerations will always be the interest rate. After all, the interest charged on your loan is what ultimately dictates the size of your monthly repayments and how much it will cost you overall to pay the mortgage off.
However, it’s not just the size of the interest rate that you need to understand when comparing mortgages, but also how the interest rate can change over the term of your mortgage.
There are two main types to consider: fixed rate and variable rate.
How do fixed-rate mortgages work?
With a fixed-rate mortgage, the interest charged on your loan will not change for a specific period. This can range from as little as two years to as long as 10 years, depending on the lender and the product you go for.
Because the interest rate doesn’t change, this means your monthly mortgage repayment will also stay the same for that fixed period.
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Once the fixed-rate period finishes, you will move onto the lender’s standard variable rate (SVR).
How do variable rate mortgages work?
As the name suggests, with a variable rate mortgage, the interest rate can change over time. In some cases you may have a tracker mortgage, where the interest rate on your mortgage follows the base rate set by the Bank of England. As a result, if the bank base rate goes up, so too will the interest rate on your mortgage, meaning your monthly repayment will rise as well.
However, if the base rate falls, your interest rate will go down, and your monthly mortgage bill will shrink as well.
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Another form of variable rate mortgage is a discount rate mortgage. This is where your interest rate runs at a discount from the SVR set by your lender. For example, if your lender’s SVR is at 5% and your mortgage runs at a 2% discount, your mortgage’s interest rate will be 3%.
Generally, the variable rate period on your mortgage runs for a set period, often two years, after which point you’ll move onto the lender’s SVR. However some lenders offer lifetime tracker mortgages, where your interest rate tracks the bank base rate for the entire term of the mortgage, which could run for decades.
The pros and cons of fixed and variable rate mortgages
The big positive for fixed rate mortgages is that they provide certainty. You know exactly what your mortgage bill will be each month for a set period, which makes budgeting a lot easier. There are no nasty surprises.
Traditionally, fixed-rate mortgages have been more expensive than variable rates, as you were paying for peace of mind. However that isn’t always the case now, with many fixed rates looking incredibly competitive.
» MORE: What is a mortgage? How it works
The longer the fixed rate period ‒ and therefore the longer you have certainty over the size of your mortgage repayments ‒ the higher your interest rate is likely to be.
That’s not to say you won’t ever find a cheaper variable rate. If you do, you will likely benefit from smaller repayments from the outset, which can make them more affordable. There is significant uncertainty involved though as it’s very easy for your rate to start accelerating, and quickly, making it more difficult to keep up with. That said, there is the potential for your rates and repayments to fall if the base rate drops.
Can I leave my rate?
Another element to think about, is whether there is an early repayment charge (ERC). This is a fee you have to pay should you opt to switch mortgages or repay it in part or in full during that initial fixed or variable period. As it is calculated as a percentage of your outstanding loan, it can easily run into the thousands.
However, some variable mortgages do not charge ERCs. In that case, if interest rates start to rise and you become concerned over whether you’ll be able to afford the repayments in future, you can at least switch to a fixed-rate mortgage. That way, you can enjoy some certainty over your repayments without having to fork out thousands of pounds for the privilege of repaying and then switching. It can also be helpful if you want to make large overpayments or repay your loan early.
How to decide whether a fixed or variable rate mortgage is right for you
The right type of mortgage for you will come down to your own circumstances and attitude towards risk. If you are risk averse, and want the certainty of knowing what your mortgage will cost you each month, then a fixed rate mortgage is likely to be most appropriate.
However, if you are happy to accept the risk of higher payments in future in order to secure lower bills at the outset ‒ and can afford those higher payments should rates rise ‒ then a variable mortgage may be an option for you to consider.
If you need some guidance, you could make use of a mortgage broker or independent financial adviser who can help you work out the best type of mortgage for you and which products you may qualify for.
» MORE: Do I need a mortgage adviser?
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John Fitzsimons has been writing about finance since 2007. He is the former editor of Mortgage Solutions and loveMONEY and his work has appeared in The Sunday Times, The Mirror, The Sun and Forbes. Read more