If you’re thinking of taking out a new mortgage in the next few months, the likelihood is you’re considering a fixed rate.
Recent figures from conveyancers LMS showed that 97% of people remortgaging chose a fixed-rate deal, and it’s a similar story for people buying a home.
So, you’ve decided to fix. Your next question is: ‘how long should I fix my mortgage for?’
Two-year fixed rates have traditionally been popular as they have offered the lowest repayments. But, as the gap between two-year and longer-term deals shrinks, is it now time to think about a five-year deal?
Keep reading to find out why a longer-term fix may be financially beneficial, and the pros and cons of each type of deal.
Gap between cost of two-year and five-year deals falls to lowest level since 2012
Historically, one of the main reasons why borrowers would choose a two-year deal was because they offered lower rates and cheaper repayments.
Last July, for example, we reported that the average two-year fixed rate deal stood at 2.52% compared to the average five-year fix which was available at 2.92%.
Borrowers taking a five-year deal understood that they were essentially paying a premium for the longer-term security. Repayments were higher because you had the peace of mind that your mortgage repayments wouldn’t change for five years rather than just two.
However, in the last few months things have changed. Financial analysts Moneyfacts recently reported that the gap between the average two-year and five-year fixed rate had fallen to its lowest level in seven years.
The average two-year fixed-rate deal is now 2.49%, compared to the average five-year fixed rate which stands at 2.85%. The gap of just 0.36% is the lowest since 2012.
Mortgage expert Danny Belton told the Daily Mirror: “Consumers want control over their finances, and as demand for five, seven and even ten-year fixes grows – lenders are reacting by lowering rates."
Why a five-year deal may be better value
There are several reasons why you might want to pay a premium for a five-year fixed-rate mortgage.
Firstly, it gives you the peace of mind that your repayments won’t change in the short and medium term. You’ll know exactly what you will pay, irrespective of what happens to general interest rates. It helps you budget and protects you against any rises in the Base rate.
Another reason you might choose a five-year product is because it reduces the need to remortgage once your deal ends.
Darren Cook, finance expert at Moneyfacts, says: “Currently, mortgage rates appear to be competitive across the board, allowing borrowers the flexibility to choose whether to fix repayments for either the short, medium or longer-term initial rate periods.
“However, borrowers must also remember to consider other factors, such as potentially greater fee expenses if they opt for a shorter initial fixed payment term and have to switch deals more frequently.”
Here’s an example.
If you took a £200,000 mortgage over a 25-year term on the average two-year fixed-rate deal, your monthly capital and interest repayments would be £896.
If you took the same mortgage on the average five-year fixed rate, you’d pay £933 per month.
Over the first two years you’d pay £888 more by choosing the longer-term deal. However, at the end of two years you’d need to remortgage to another product, and this is where additional fees could come in.
When you come to remortgage you could pay:
- A booking or product fee for your new rate – often £999 or more
- A valuation fee
- Legal/conveyancing fees
- A fee to your mortgage broker
- Closing/admin fees to your current lender for repaying your mortgage
Writing in the Daily Mirror, John Fitzsimons says: “Currently, the average [remortgage] fee is about £1,000. Given a five-year deal means paying that once, and a two-year one means paying it two-and-a-half times, that means you lose out…by going with a five-year deal.
“And if you end up paying above average fees, or rates rise over the course of the next five years, all of a sudden the five-year can work out cheaper.”
There are good reasons why you might currently want to choose a longer-term fixed rate. However, there are several factors you should bear in mind when you’re considering a five-year (or longer) fixed-rate deal.
When a five-year fixed rate might not be right for you
As we have seen, fixing your mortgage payment for five years gives you the security that you know what your repayments will be in the short to medium term.
However, there are some factors to consider before you commit to this type of deal. There are some cases where a two-year fixed rate may still be a better option for you.
For example, if you know that your circumstances are likely to change in the next five years and that you’ll either want to move home or pay off a portion of your mortgage then a five-year deal could be prohibitive.
Five-year fixed rates typically come with substantial ‘early repayment charges’, which are often charged at a percentage of the amount you repay. Redeeming a mortgage with a 5% early repayment charge could cost you many thousands of pounds.
Read: Everything you need to know about Early Repayment Charges
If you move home, then many lenders will let you ‘port’ your existing mortgage to avoid paying these charges.
However, they will underwrite your mortgage application from scratch, so if your circumstances have changed (or the lender’s criteria have changed) since you originally took out your mortgage, you may find they can no longer approve the borrowing you need.
Read: What you need to know about porting a mortgage
Similarly, if you’re locked into a five-year deal and interest rates fall, you won’t see any benefit from this. You could end up in a position where you’re locked into a deal which is more expensive than the current alternatives.
With a two-year product, you may be able to take advantage of these cheaper deals sooner. Remember, however, then there may be remortgage fees to pay which can eat into the savings you make.
A mortgage broker can look at the various options for you and work out which is likely to be the most appropriate deal for you.