When you're after a mortgage, the big questions is often 'Should I fix?' This is a full Q&A 'fixed v discount' guide to help you decide what's right for you, plus if you're locked into a high rate, there's the quick 'should I ditch my fix?' calculator.
The BIG info
Q. How do fixed rates work?
A When you fix, the rate doesn't change for a set time. It's, well...er...fixed! So a fixed rate of 5% for two years means this IS what you'll pay, irrelevant of any UK interest rate changes or owt else.
Think of a fixed rate like this; in return for signing up to the mortgage, the lender is agreeing to give you a short term special rate. If you try to change mortgage during that period, you'll almost always have to pay a large penalty, effectively locked you into it for a set time.
Yet the big advantage of fixed deals is you know EXACTLY what you'll pay, giving security and meaning you can budget around it.
Q. The difference between a discount and a tracker?
A Both discounts and trackers are types of variable rate mortgages, where the interest rate you pay can and usually will change over time. In fact the two terms aren't exclusive, as there are such things as 'discounted tracker' rates. To explain it, lets go back to basics.
If you get a variable rate mortgage, the amount you pay is usually based on one of two underlying rates...
Lenders' Standard Variable Rates (SVRs).
Each lender sets its own SVR and while it tends to move up and down with the UK base rate, it doesn't have to. In fact it can move willy-nilly based on the lenders' own competitive reasons. The most important thing to remember is...
Lenders can do whatever they want with their SVRs. You have no guarantee on what'll happen with it.
Of course competitive pressures, Government scrutiny and press attention mean most of the time it moves in the same direction as UK base rate changes, but not necessarily by the same amount.
The Bank of England Base Rate (Trackers)
Tracker mortgages mean the rate is guaranteed to move with UK base rates , which are set each month by the Bank of England.
Yet it doesn't mean your mortgage rate will be the same as the Bank of England rate, e.g. a 'Base Rate + 1%' tracker means the underlying rate of the mortgage will always be one percentage point higher than current UK base rates.
Thus on the surface it seems like a tracker is better than an SVR deal, as it's guaranteed, yet the tracker could be set at a higher start rate than the SVR, and that sways the balance. Plus some trackers have a minimum rate level, which sets a certain amount below which your rate won't go.
What's the discount off?
Discount rates are short term special offers to suck in your custom. The rate starts much cheaper than normal, usually for two to five years, though you will often need to agree to pay a hefty penalty if you want to repay or switch the mortgage within that time.
Just as there are two underlying rates, there are two types of discount.
When discounts are usually talked about, it means a discount off the SVR. For instance, you may get a two percentage point discount off the SVR for the first three years.
Discounted Trackers. Here you get a discount off the standard tracker rate, eg. a two percentage point discount off the tracker rate for the first three years. Yet in this case you need to be careful to understand EXACTLY what it means...
Ray Treducer has spotted a mortgage offered with a 1.5% discount off the normal tracker rate for three years. He checks and finds the normal tracker rate is 'Base Rate + 2%' tracker.
To find his mortgage rate, Ray has to subtract the discount from the normal tracker rate. That means he will be paying 0.5% more than UK base rate for the first three years of his mortgage.
It's what you pay that counts.
It's not the size of the discount that counts, but the underlying rate you pay. Don't be drawn in by the discount size, examine the entire rate.
Barstools Bank. This has a huge 2% discount for two years, but the underlying Standard Variable Rate is 5.5%. In other words the rate you actually pay is 3.5%.
Q. How to pick fixed vs discount?
A Traditionally, fixed rates are set slightly higher than discount rates; though that varies due to the overall economic climate. The most important thing to remember is...
With a fixed rate you have the surety of knowing EXACTLY what your mortgage repayments will be for that time.
This is the crucial factor; deciding whether to fix is a question of weighing up how important that surety is for you.
It's a 'how close to the edge are you?' question
There are no hard and fast rules but one way to think of this is, the nearer you are to the financial edge, the more you should hedge towards getting a fixed rate.
Those who can only just afford their mortgage repayments should think carefully before gambling with interest rates and lenders' whims. A fixed rate has the advantage that you can budget for the repayments, and be sure they won't increase.
Those with lots of spare cash over and above the mortgage can focus simply on getting the best deal, whether it's a discount or a cheap fix.
By taking a discount you're taking a little gamble on how interest rates will move. The question to ask yourself, is 'could I afford to lose?'. This means, if interest rates jumped, could you afford the payments comfortably? If you can, and the discount is cheaper, go for it.
Yet, if losing could mean financial disaster, stick with the fixed rate.
Don't look back in anger
Now for something you'll rarely read on this site. If you've gone for a fixed rate for surety, it's often best to shut your eyes for a little bit. Regardless of what happens to interest rates, you wanted payment security and you've got it. Well done.
You can't have hindsight in advance, so thinking "if only I'd..." doesn't help anyone; unless you had a crystal ball. Even if it turns out it would've been cheaper to take a discount, that doesn't mean going for a fixed rate was the wrong decision. Think of it a bit like this...
The wrong answer isn't always the wrong bet.
Let me offer you a hypothetical bet on a simple head or tails coin toss, with one big change... if you win I'll give you £100, but if I win you only need to give me £1. No con tricks, no sleight of hand. Would you take the bet?
While it's still 50-50 odds, the downside is small, you'd only lose a pound; while the upside is huge, you'd get £100. So almost certainly, if you can afford to lose the pound, you should take the bet.
So let's toss the coin.... YOU LOSE!
The fact you lost doesn't mean it was a bad bet.
The same is true with taking a fixed rate. If you are doing it because personal circumstances mean surety counts, if the facts after the event show a discount would've won, that doesn't make your choice wrong.
It's the overall rate that counts
As rates change over time, simply comparing the fixed and discount rates at the point you take your mortgage is a relatively blunt tool. To work out which is truly a better deal, you need to look at how much interest rates would need to change before one deal beat the other.
Q. Should I ditch my fix?
A As of August 2012, base rates have been at their lowest level ever for three and a half years. Anyone who took out a long fix a few years ago may be locked into a rate a good few percentage points above those on tracker deals or even Standard Variable Rates, and asking "should I ditch my fix?". There are a number of variables that impact the answer:
Loan-to-values (LTV). Only those borrowing LESS than 90% of a home's current value are likely to get competitive deals, with rates getting much better the lower your LTV (sub-75% is where the great rates hit).
The penalty. Most fixed-rate deals have big penalties if you leave early. Yet a £1,000+ penalty could be worth paying, for a really big cut in rate.
The go-to rate. It's possible the standard variable rate the mortgage'll go to when the fix ends is cheaper than new deals anyway, and won't cost a fee. And thus waiting for this may be far cheaper
When it ends. If your deal ends within a few months, it's unlikely to be worth paying a penalty. Yet ditching & switching's more attractive if you've longer left.
The 'Should I Ditch My Fix?' Calculator
This calculator works out what interest rate you'd need to get to make it worth ditching your fix. If the answer is negative, it simply means it's not worth it. Mortgages are complex though, so take this only as a rough ready reckoner.
What to do if you CAN save
If the tool tells you it is possible to ditch, switch and save, it's time to make your checking serious
Are deals that cheap available?
The rate you need to achieve to make switching worth it may not be possible in the present market, or you may not have a low enough LTV to successfully apply for it.
To find out what's available, speak to a whole-of-market mortgage broker, who'll scour the market and find the best deal possible for you. Read the Cheap Mortgage Finding guide for full details.
Do the numbers properly
This calculator gives a rough indication whether you may be able to save. Yet the details will be more complicated, with arrangement fees, mortgage exit fees, legal and valuation charges all possibly skewing the balance. Use a broker to do the sums, and read the free full Remortgage Guide to walk you through the process
- Think through whether you really want to lose a fix?
If you got the fixed rate for surety, are you truly sure you want to get rid of it? Especially if the saving is small or you're planning to move to a variable rate. Predicting future interest rates is a nightmare, so it's not simply a case of lower cost right now is the best deal, think about your situation over a longer period.
Discuss this/Report your result: Should I Ditch My Fix?
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Q. What is a mortgage collar / minimum rate?
A Tracker mortgages are supposed to follow the base rate as it drops (or rises). Yet some limit the minimum amount you will pay, so the rate can never go lower than a certain level. This works in one of two ways, though both have the same end result.
Collars. A collar sets the minimum amount the lender will consider the base rate to be. Imagine a tracker 1% point above base rate but with a 3% collar. No matter how far below three percent the base rate drops, you will still pay 4% (the 3% collar plus 1%).
Minimum Rate. Here the restriction is imposed on your mortgage interest rate, rather than the base rate. Imagine a tracker 1% point above base rate but with a 3% minimum rate. If the base rate drops below 2%, your rate will remain at 3% (as that's the lowest it can go).
The regulator, the FCA, says collars (and it's likely this applies to minimum rates too) may be invalid if they "weren't in the Key Facts Document (KFD) when you got the mortgage". Therefore do the following...
Check if your mortgage has a collar. Simply call up and ask if it has a collar or a minimum rate, then follow below. If not, there's no issue.
Find your key facts document. You should've got this when you first got your current mortgage deal. If it doesn't mention the collar or minimum rate, then you can argue it's invalid.
Call it up and put a note on your file. If it's not in the Key Facts Document, call up the lender now and ask for a note of dispute to be added to your file to say you do not accept the collar (or MR). If rates do drop below that and they activate the collar, put in a free complaint to the Financial Ombudsman.
Q. How are fixed rates priced?
A When getting a new fixed rate, the interest it's set at is not always closely aligned to the base rate. Very roughly, the fixed rate is priced due to the financial community's view of what'll happen to interest rates over the fix period. This means base rates could be going up in the short term but fixed rates are coming down as long term trend is different.
Lenders price their deals according to the cost of money they buy on the wholesale money markets, and the economic situation means this has become much pricier than base rates.
Fixed rates tend to be sold in tranches, ie. a lender will put, say, £50 million worth of mortgages out there at a rate, and once it's gone, it's gone. This means if fixed rates are generally moving up, move quickly and you may be able to secure some of the old tranche before it sells out.
While this divergence of fixed rates and base rates can insulate you from the effects of any rate rises during the period of the loan, if rates have gone up, you may face a steep increase at the end of the deal, so-called 'rate shock'.
Q. What does a mortgage APR mean?
A This is a common confusion for people getting mortgages out. They're often advertised with two rates, the higher one is usually the APR. This is because lenders are forced by regulation to include it.
While the reasons behind APRs are good, actually in many mortgages they're not that relevant. The Annual Percentage Rate is the equivalent interest cost over the FULL TERM of the loan, including all interest and fees
For example, a two year fixed rate at 3% may have an APR of 6%. This means if you kept the mortgage for the full twenty five years, you'd pay the equivalent of six percent a year. APRs have traditionally been higher because Standard Variable Rates are set higher than the short term introductory deals like fixed or discounts; plus any legal, valuation or other fees need including.
Yet if you're not planning to keep the mortgage deal for long, and are only borrowing a smaller portion of your home's value, meaning you should be able to continue to remortgage, it's best to focus on the short term rate and the fees, mostly ignoring the APR.