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Tuesday 21st May 2024

Mortgage rates are falling, but is now the right time to fix your home loan?

If you’re one of the 1.8 million borrowers whose fixed rate mortgage is up for renewal this year, you may be in for a shock.

Mortgage rates have soared over the past 12 months, meaning you’ll probably have to pay more when you remortgage.

Many borrowers are locking into longer-term fixes in case rates rise even further.

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However, with the outlook for interest rates uncertain, that may not necessarily be the best idea.

To help you decide what to do next, Mouthy Money weighs up your options.

Why have mortgage rates risen by so much?

But first, why have mortgage rates risen so much?

In short, because the Bank of England (BoE) has hiked Bank Rate – the UK’s most important interest rate – to a 14-year high of 4% over the past 15 months.

That’s because the price of goods and services – otherwise known as inflation – has soared to a near 40-year high. There are a number of reasons for this, including the fallout from Covid, supply issues and the war in Ukraine.

The BoE hopes that by hiking borrowing costs people will spend less and save more, and thus prices will fall. That’s the theory, at least.

But that policy, of course, has a negative knock-on effect on mortgage borrowers.

When Bank Rate is rising, it tends to push up swap rates, which banks use to price their fixed-rate mortgages.

And so when swap rates rise, mortgage rates tend to as well. This is what we have seen over the past year.

According to data firm Moneyfactscompare.co.uk, the average five-year fixed rate has rocketed from 2.88% to 5% in the past 12 months.

On a £200,000 25-year mortgage that works out at an extra £234 a month. That’s a lot of money for people to find in the middle of a cost-of-living crisis.

However, there is a silver lining.

Rachel Springall, finance expert at Moneyfactscompare.co.uk, points out that rates have actually rolled back in recent months.

The firm’s data shows the average five-year fixed rate has fallen more than 0.6 percentage points since January. Two-year deals have fallen by 0.47 percentage points over the same period.

Springall says: “Mortgage pricing fluctuates for a few reasons, but thankfully fixed rates have been coming down over recent weeks, which is good news for borrowers looking for a new deal.”

If rates are falling, does that mean they will continue to fall?

Without a crystal ball, it’s impossible to say.

Markets – shorthand for professional investors – predict the BoE will stop increasing Bank Rate when it hits 4.5%. That is just 0.5 percentage points higher than now.

Those same observers believe the BoE may even start cutting rates at some point in 2023 or 2024.

However, investors are constantly revising these estimates based on what is happening to inflation and the wider economy.

For example, if inflation remains high, the BoE might decide to hike rates higher than expected.

On the other hand, if inflation falls quickly or the economy starts to struggle, the BoE may decide it has some scope to lower interest rates.

Either way, it will probably have a knock-on effect on the price of mortgages.

So what should I do now?

Typically, you can apply for a new mortgage once you have six months or less remaining on your existing deal.

If that’s you, now is the time to start shopping around or to get in touch with your mortgage broker.

A good broker will scour the market looking for lenders offering the best deals. But it’s also worth checking what your existing lender is willing to offer.

Sometimes, lenders offer what are called ‘product transfers’ or ‘rate switches’ to their existing customers. These have their benefits and drawbacks.

On the one hand, the fees on product transfers tend to be much lower, potentially saving you money. There is also far less paperwork and, often, you don’t need to pass another credit check. That’s handy if your financial situation has changed since you last took out a loan.

However, your current lender may not offer the best rates, meaning you could be missing out on a better deal elsewhere.

OK, got it. Should I go for a fixed rate then?

That’s a difficult question to answer as everyone’s circumstances are different.

Fixed rates are best suited for borrowers who want payment certainty, Hollingworth says.

That’s because the monthly repayment stays the same for the duration of the fixed rate period, regardless of what the BoE does with interest rates.

So, for example, if you take out a two-year fix, your monthly repayment will be fixed for two years. Likewise, if you take out a five-year fix, they will be fixed for five.

However, they often come with steep penalties if you want to break the deal early.

For example, let’s say you’re in the first year of a five-year fixed rate and you see a better deal .

To take advantage of that better deal, you’ll first have to break free of the five-year fixed rate you’re on. To do that, you’ll have to pay the lender’s so-called early repayment charge (ERC).

ERCs can be as much as 5% on a five-year fixed rate. Or, in other words, £10,000 on a £200,000 loan.

David Hollingworth, of mortgage broker L&C Mortgages, says: “Fixed rates give peace of mind which is something that households will be craving during such a volatile period of rising costs and high inflation. 

“Thankfully rates have dropped substantially since they rocketed after the mini Budget although they remain substantially higher than the ultra-low rates that borrowers have enjoyed in recent years. 

“That may mean that locking into a fixed rate is a useful way to ensure that the mortgage payment will not rise and fall with interest rates and give some budgeting security when other costs are fluctuating.”

The next question is: if you’ve got your heart set on a fixed-rate, how long should you fix for?

The answer to that depends on what you think will happen to interest rates. If you think interest rates will stay high, you might want to opt for a five-year fixed rate.

However, if you think interest rates will fall in the coming years, a two-year fixed rate may suit. That way you’re not locked into a more expensive deal long-term when rates are falling

It’s worth noting, though, that two-year deals are currently more expensive, typically, than five-year fixed rates.

Whereas the average five-year fixed-rate is currently 5%, the average two-year fixed rate is 5.32%, according to Moneyfactscompare.co.uk.

However, remember, those are average figures. You can get much better deals by shopping around.

In fact, someone with a 40% deposit can currently get a five-year fixed-rate from first direct for 3.99%. That works out at £1,054 a month on a £200,000 loan over 25 years.

Hollingworth says: “Unusually we have a situation where medium to longer-term fixed rates are lower than shorter-term rates. That’s because markets expect that the recent in spike in interest rates may stabilise over time, But with lower rates and an uncertain back drop, many borrowers will like the look of the lower five-year rates and the stability to ride out any further ups and downs.”

Ten-year fixed rates provide even more long-term certainty. However, Hollingworth says these products are not suitable for everybody.

He says: “Ten-year fixed rates can limit flexibility for the borrower if they need to review the mortgage and some will still be hoping that recent rapid rises in interest rates will ease back further over time. There’s no guarantee of that of course and longer-term fixed rates can be ideal for those that want to know exactly where they stand.

“Shorter-term fixed rates, on the other hand, are currently higher but some borrowers may feel that this is a temporary state of affairs and that interest rates may need to drop back once inflation eases.   

“If that transpires and interest rates fall then it could leave borrowers looking at a more competitive landscape when they exit a shorter-term fix. 

“However, there’s absolutely nothing to say that things won’t go against them and we’ve seen how rapidly market conditions and sentiment can shift.  It’s therefore worth thinking ahead in case rates don’t move as hoped.”

Another popular option, of course, is a tracker mortgage. Unlike with a fixed rate, tracker mortgages move in line with interest rates.

For example, if the BoE hiked interest rates by 0.5 percentage points tomorrow, your rate would jump by the same amount.

Currently, Halifax offers one of the best two-year trackers at 4.23% for those with a 40% deposit. That works out at £1,081 a month on a £200,000 loan over 25 years.

However, if the BoE raised rates by 0.5 percentage points, you’d end up paying £57 more a month.

Conversely, if the BoE cut rates by 0.5 percentage points, your monthly repayments would fall by £55 a month.

While trackers provide less certainty than a fixed rate, they are usually much more flexible.

For example, unlike fixed-rates, trackers often don’t come with penalties for ending the deal early.

Therefore, a tracker may be an option if you value flexibility and plan to ‘wait and see’ if the BoE reduces interest rates, as expected.

However, as Hollingworth points out, that’s a risk as there is no guarantee that will happen: “A variable or tracker deal does not give the protection against further rate hikes. 

“If rates don’t come back down then the tracker could prove more expensive and borrowers need to have the ability to deal with the potential for higher payments. 

“It therefore makes sense to opt for the deal that works best for you and some will prioritise peace of mind at such an uncertain and volatile point in time.”

Photo Credits: Unsplash

Paul Thomas

Co-editor

Paul Thomas is a former national newspaper journalist and magazine editor. Used to look like that guy Jamie from Coronation Street; then I got heavy.

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