Fixed-rate vs. variable-rate mortgage: which should I choose?

A recent study by financial solutions company ThinkMoney.com showed a recent shift in the type of mortgage homebuyers were more inclined to buy.

Of those who bought their homes three or more years ago, 47% chose fixed-rate mortgages, while 42% chose variable-rate. When compared with those who bought their homes in the last year – of whom 76% chose fixed-rate mortgages, against the 9.1% who chose variable-rate mortgages – it is evident that there has been a major shift in the type of mortgages that is more attractive to customers.

But why is this? And does this mean that fixed-rate mortgages are the ‘best’ option in the current economic climate?

Here we look at the pros and cons of the two main types of mortgage, to help you decide.

Fixed-rate mortgages

Pros:

• Offers security. Homeowners on fixed-rate mortgages know how much they will pay every month, with no risk of this amount changing until the mortgage terms are over.
• Rates can be fixed for several years – usually two or three years, but they can potentially be fixed for the entire duration of the mortgage.

Cons:

• If interest rates fall, your fixed-rate mortgage may end up costing more than the variable-rate equivalent.
• Fixed-rate mortgages often come with expensive mortgage arrangement fees.
• Early repayment charges are likely to stand, for at least the duration of the fixed period.
• Once the fixed period has finished, you will normally pay the lender’s standard variable rate (SVR), which usually means much higher monthly payments, unless you remortgage.

Variable-rate mortgages

Pros:

• If the Bank of England base rate falls, your monthly payments will fall.
• If you want to change to another type of mortgage (e.g. fixed-rate), you are less likely to incur early redemption fees.
• At the time of purchase, interest on variable-rate mortgages is usually lower than the lender’s fixed-rate equivalent – so you should start off paying less.
• Most variable-rate mortgages do not charge an arrangement fee.

Cons:

• If the base rate goes up, so will your payments. (However, some deals put a ‘cap’ on how high payments can go.)
• Variable-rate mortgages are difficult to budget for, since it’s impossible to be sure how much your monthly payments will cost.

Which mortgage is right for me?

This is largely down to your own circumstances, and how much of a risk you are willing to take.

Fixed-rate mortgages are essentially the ‘safe’ option. You can plan ahead for the duration of the mortgage terms, knowing exactly how much you will pay towards your mortgage each month.

If you are left with little disposable income once all your commitments have been paid, a fixed-rate mortgage is probably the best option, because you know there will be no nasty shocks that leave you unable to meet payments. However, you will pay up front for this security in the form of a mortgage arrangement fee.

Variable-rate mortgages are more of a risk, but can potentially give the best rates – so long as the Bank of England base rate does not rise too much. Since they (usually) avoid a mortgage arrangement fee, they are also much cheaper to begin with.

In the current economic climate, in which costs of living and inflation rates are on the rise, many people prefer the security of a fixed-rate mortgage – which explains the recent rise. But if you think you have the financial headroom for any potential rises in costs, a variable-rate mortgage could be the cheaper option in the long run.

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