Choosing a fixed rate or a variable rate is one of the first decisions you’ll have to make when it comes to deciding what kind of mortgage is right for you.
Here’s what’s the same about them: both fixed and variable rate mortgages will have a “deal” period – that’s how long the interest rate you’re signing up for lasts. You can choose either:
- A mortgage with an initial period
(usually 2, 3, or 5 years), where you pay a discounted interest rate for a limited period of time, after which you remortgage or slip onto your lender’s default rate (more about that below)
- Or, a mortgage with a rate that runs over the whole term of your mortgage
– a full term fixed rate mortgage like Habito One
, or a lifetime tracker rate (a type of variable rate mortgage).
If you go for a mortgage with an initial period, after your initial period is up, it’s up to you to remortgage (switch) to a different fixed or variable rate deal with a new initial period, or you’ll be slipped onto your lender’s standard variable rate (SVR). SVRs are usually higher than the interest rate you were paying during the initial term. (Read more about remortgaging here
So, with that said, here’s what’s different between a fixed rate and a variable rate mortgage:
Fixed rate mortgages
With a fixed rate mortgage, the interest rate you pay on your loan is guaranteed to stay the same – for a period of time. Fixed rate mortgages with initial periods usually range from 2 to 10 years – the longer you want that initial period to be (to “set it and forget it”), usually, the higher the interest rate is. During the initial period, you know exactly what your monthly payments will be. Full term fixed rate mortgages (like Habito One
) fix your rate and repayments for the entire duration of your mortgage.
Almost all fixed rate mortgages come with an early repayment charge (ERC) during the initial period, which is a fee you have to pay (usually one or two percent) if you decide to, for example, overpay your mortgage, or sell your home, during your initial period. (Habito One
doesn’t have an ERC.) Your mortgage expert can help you figure out if having an ERC matters for you or not.
The benefit of a fixed rate mortgage is that you know exactly what you’ll be paying for the period of time you fix for – your payments won’t go up or down, so your outgoings will be stable. And you’ll pay a little bit more for that stability – fixed rate mortgages have slightly higher interest rates than variable mortgages.
Variable mortgages: Tracker
Tracker mortgages work by tracking – as you might have guessed – a particular interest rate, usually the Bank of England base rate, and adding a certain amount on top.
With a tracker mortgage, your monthly repayments will rise and fall as the interest rates do. So if the base rate goes up, your payments go up. If interest rates go down, so will your payments. You’ll need to consider how you’ll budget for increases in mortgage payments – your broker can help you with this.
Because tracker mortgages are a bit more uncertain, their interest rates are, on the whole, a little less than fixed rate mortgages. It’s more common for tracker mortgages to have no early repayment charge, so you can move home or overpay before your initial period is up without being penalised.
Variable mortgages: Discounted rate mortgages
A discounted rate mortgage gives you a discount on your lender’s standard variable rate (SVR) for an initial period, usually 2, 3 or 5 years.
They’re not the same as a fixed rate mortgage, because they’re still tied to a variable rate (the lender’s SVR) – so if your lender raises interest even a little, that can increase your monthly repayments. And unlike being on an SVR, they usually do include a fee for paying off your mortgage early or remortgaging, though only during the initial period.
The total cost of a mortgage
Interest rates alone can’t tell you which mortgage is cheaper. That’s because a mortgage might have a lower rate, but end up costing more because of fees. So when we talk about the ‘total cost’ of a loan, we’re factoring in the interest rate, fees, incentives – all the money you have to pay the lender, usually assessed over the initial period of the term.
Let’s say you want to borrow £200,000 over 25 years, and you’re comparing loans from two different lenders.
See how even though the first interest rate looks lower, it’s actually a higher total cost when you add it up over the 2 years of the initial period: