Those buying a property or remortgaging this year face a decision that could save them – or cost them – thousands of pounds, depending on whether they choose correctly.
That decision is whether to fix their mortgage for two or five years.
Before interest rates surged higher towards the end of 2022, five-year fixed rate mortgages were proving popular with roughly three in five borrowers opting for them.
At that time, mortgage rates were relatively low, but rising – so locking in for as long as possible seemed a good idea.
Since then, rates have spiked and increasing numbers of people are now opting for two-year fixed rate deals in the hope they will have fallen by the time they next come to remortgage.
Two-year preference: More than half of Britons opted to fix their mortgage for two years in December, according to the UK’s largest online mortgage broker, L&C Mortgages
Last month, more than half of Britons opted to fix their mortgage for two years, according to the UK’s largest online mortgage broker, L&C Mortgages.
This is very different from what people were doing for much of 2022, when roughly a quarter of borrowers were opting for two-year fixed deals, according to the broker.
This is all the more surprising given that five-year fixed rates tend to be cheaper than two-year deals at the moment.
The average two-year fixed rate mortgage is currently 5.93 per cent, according to Moneyfacts. That compares to 5.54 per cent for five-year fixes.
Those with the biggest deposits or with larger equity stakes in their home can also do much better when fixing for five years, rather than two years.
The lowest two-year fix on the market is offered by Leeds Building Society charges 4.6 per cent, while the lowest five-year fix is with Generation Home at 3.94 per cent. Both deals come with a £999 fee.
Why this shift in fashion?
Many of those opting for a two-year fix will be doing so because they think interest rates will fall over the next couple of years.
They are essentially banking on the expectation that once inflation subsides, the base rate – and then mortgage rates – will come down, allowing them to fix at a cheaper rate.
Nicholas Mendes of mortgage broker John Charcol says: ‘At current market pricing, two-year fixed rates are reducing and are certainly more affordable than earlier last year.
‘It would be worthwhile to consider the short term pain, rather than be tempted by some of the five-year fixed rates currently on offer.
‘Fixed rates are expected to continue to decrease so you don’t want to be tied into a higher rate for longer than you need to be.
‘It may also be worth considering a three-year fix if you want stability for slightly longer than two years, but to avoid being tied in for five.’
Worry: For homeowners whose fixed rate mortgages are set to expire in 2024, the prospect of transitioning to a higher mortgage rate may be a cause for concern
That said, while five-year fixed rates are no longer the product of choice, they were still the preferred option for roughly one third of mortgage borrowers last year.
This is because they offer the cheapest rates, and also certainty over monthly payments for the next five years. This will appeal to some borrowers, given how much interest rates have shot up over the past 24 months.
On the flip side, fixed rate deals come with early repayment charges that can make remortgaging early a costly business.
It means most borrowers are essentially locked in for the next five years and will be unable to take advantage if rates fall.
Mark Harris, chief executive of mortgage broker SPF Private Clients says: ‘If I were taking out a mortgage this year and my budget was tight, I would opt for a five-year fix, as it’s better to be safe than sorry. That would enable me to budget for a reasonable period of time.’
Five year fixes can also be handy in that they can in some cases enable people to borrow more than might be possible with a two-year fix.
‘There are several lenders who, on a residential basis will give you more borrowing on a five year than on a two year deal, says Chris Sykes of broker, Private Finance.
‘This is because of better rates on a five-year deals, and the longer term nature allowing lenders to stress test at a lower percentage, as there is greater longer term certainty with the loans.
For exammple, one client I recently advised was able to borrow a maximum of £621k with one specfic lender if they fixed for five years. However, if they went with the two year option the maximum they could borrow fell to £568k.’
What about tracker mortgages?
Those that are confident of rates falling faster and further than expected may even be trying their luck with a tracker mortgage.
Trackers follow the Bank of England’s base rate, plus or minus a set percentage.
For example, someone could be paying base rate plus 0.75 per cent on top with a tracker. With the base rate at 5.25 per cent, they’d pay 6 per cent at present.
But if the base rate was cut to 4.5 per cent, for example, their rate would fall to 5.25 per cent.
The main benefit of tracker deals is that they typically don’t come with early repayment charges.
This means if mortgage rates fell over the coming year, someone with a tracker deal could switch to a cheaper fixed deal as and when they liked.
Take a risk: Those that are confident of rates falling faster and further than expected may even be trying their luck with a tracker mortgage
On the flip side, if the base rate stays the same or even rises this year, it could end up becoming an expensive gamble.
Last month, almost 10 per cent of mortgage borrowers opted for a two-year tracker mortgage, according to L&C.
In August and September this year, shortly after mortgage rates peaked, more than 15 per cent of borrowers were opting for these tracker deals.
‘If I could afford to be wrong and could cope with fluctuations in rates, then a base-rate tracker with no early repayment charges could be worth considering and monitoring the market closely,’ adds Harris.
‘Should fixed rates come down, you could then move over to a new rate without having to pay a penalty.
‘As always, it is worth using a whole-of-market broker to ensure you get the right advice and deal for your circumstances.’
Will mortgage rates fall in 2024?
The past two years have seen the Bank of England raise the base rate from 0.1 per cent to 5.25 per cent.
But now the spotlight has shifted to when the Bank of England might begin to make cuts.
Richard Harrison, head of mortgages at Atom Bank, says: ‘Although Andrew Bailey has cautioned against premature considerations of rate cuts, the reality is that future rate expectations will significantly influence mortgage pricing.
‘In recent weeks, rates have already seen a noticeable decline. Barring any unforeseen developments, this trend is likely to persist next year, resulting in more competitive rates across the board.’
According to bets on financial markets, the Bank of England will cut rates six times in 2024, taking them from a 15-year high of 5.25 per cent today to 3.75 per cent by Christmas.
That would be a major boost for borrowers needing to remortgage and first-time buyers getting on to the housing ladder.
However, mortgage rates will still be far higher than they were before interest rates started rising at the end of 2021.
> When will interest rates fall? Forecasts on when base rate will go down
Mendes of John Charcol believes the cheapest five-year fixed rates could reach below 3.5 per cent during the second half of the year.
‘January is a fresh start but it is also crucial for lenders to set the foundations for a successful year. Lenders are wasting no time this time round and starting the price war earlier, which has certainly caught a few by surprise, myself included.
‘At the start of the year, we should see more lenders release sub 4.5 per cent five-year fixed rates, with more best buys below 4 per cent.
‘We will also see two-year and three-year fixed rates coming down to below 4.5 per cent.
‘By Spring to mid-2024 expectations of a sub 3.75 per cent deal will be on the cards as markets continue to price in a reduction to bank rate in future years.
‘During the second half of this year, depending on inflationary data and the wider economic and political landscape, we could see five-year fixed rates be the first to see a sub 3.5 per cent rate, with two-year and three-year fixed rates then breaking the 4 per cent benchmark.’
Falling: Rates have already seen a noticeable decline and barring any unforeseen developments, this trend is likely to persist next year, according to analysts
However, not all brokers are confident rates will fall by so much.
Mark Harris, chief executive of mortgage broker SPF Private Clients, says: ‘Fixed-rate mortgages will be lower than base rates in a period when interest rates are predicted to fall.
‘We are seeing that currently with lenders reducing their fixed-rate mortgages, a trend we expect to continue into 2024.
‘The market is in general agreement that base rate will fall, it is a question of when, and at what pace.
‘We would suggest that the Bank of England will reduce base rate around May or June, with rates ending the year somewhere between 4 and 4.5 per cent.’
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