Fixed or Variable Mortgage – What is the Difference?
Mortgage interest can be charged in two ways: through a fixed rate, where the interest rate remains the same for a certain period of time, or a variable rate, where the interest rate can change, and move both up or down at your lender’s discretion or in line with the Bank of England base rate.
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. Read on to find out whether a fixed or variable mortgage could be better for you.
Fixed vs variable mortgages
Which type of mortgage is best suited to you will depend on your financial situation and how much risk you’re willing and able to take. If you simply cannot afford the risk of your mortgage repayments going above a certain amount, a fixed rate mortgage will give you this security.
But if your finances allow for the chance that your mortgage repayments might rise, a competitive variable rate mortgage might allow you to take advantage of lower interest rates initially, and offer the potential for your payments to fall.
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, or perhaps even more, 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.
Once the fixed-rate period finishes, you will move onto the lender’s standard variable rate (SVR).
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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 changes in 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%.
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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.
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Is a fixed rate mortgage better than a variable mortgage?
The big positive for fixed rate mortgages is that they provide certainty. You know exactly what your mortgage payment 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.
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. The risk is that it’s very easy for your rate to start rising, and quickly, which will make your repayments more expensive as a result. But on the other hand, there is the potential for your rates and repayments to fall if the base rate drops. And if you’re locked into a fixed rate, this is something that definitely won’t happen.
Are there differences if you want to leave your mortgage?
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 earlier than expected. As it is usually calculated as a percentage of your outstanding loan, it can easily run into the thousands.
Most fixed rate mortgages will have an ERC that applies during the initial fixed rate period. Typically the percentage payable will decrease as you get closer to the end of your deal, and then won’t apply at all once your fixed rate period is at an end.
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 mortgages, without needing to pay a potentially hefty ERC to exit your current deal. 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
Ultimately, 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 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, talk to 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.
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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
Tim draws on 20 years’ experience at Moneyfacts, Virgin Money and Future to pen articles that always put consumers’ interests first. He has particular expertise in mortgages, pensions and savings. Read more