The mortgage dilemma: to fix or not to fix

For Gabe Stones, deciding what kind of a mortgage to take out “literally feels like a gamble”.

A video games artist in his thirties, Stones lives with his partner in a two-bedroom flat in east London, which the couple bought as their first property five years ago.

In the heyday of ultra-low interest rates, they secured a mortgage at a five-year fixed rate of 1.9 per cent. With their fix expiring in a month, they now face the formidable challenge of refinancing at rates around twice as high — even though they are fortunate in only needing to borrow about 50 per cent of the value of the home.

What’s more, Stones suspects they might struggle to pass an affordability test with a new lender, as their personal circumstances have changed: they now have two young children; and his partner, made redundant during her maternity leave, has seen her income decline as she turned to freelance work.

This has left him, like borrowers up and down the UK, facing a crunch decision: how to keep monthly mortgage repayments as low as possible, without locking into a deal that later leaves them paying over the odds in a shifting climate for inflation, interest rates and the mortgage market.

“It is a real dilemma for people at the moment,” says Simon Gammon, managing partner at mortgage broker Knight Frank Finance. “Are we at the bottom on mortgage rates, or is there a pause while we wait to get on top of inflation and we start to see rates fall a bit further?”

For many, these are far from academic questions. An estimated 1.7mn people will come to the end of their fix in 2023, according to the Bank of England. Banks eager for new mortgage business have chased down rates from their highs of late 2022, but with margins tightening, there is little room for further big moves.

In making a call on the issue of the moment — where inflation and base rates will lead over the next few months — borrowers refinancing what is typically their biggest asset will make a decision with consequences that could stretch all the way to 2028 — and spell the difference between securing an affordable mortgage and hitting a financial crunch point.

Fix now or take a breath?

For more than a decade, borrowers grew accustomed to choosing a fixed-rate deal — often the shortest and cheapest — knowing they could roll on to a comparable rate or better when the fix ended.

As interest rates and inflation have soared over the past year, however, well-worn assumptions about the mortgage market have been overturned. The refinancing decision now involves balancing the pros and cons of fixed and floating rates and the impact of fees. And the cheapest deal is no longer the classic two-year fix, but the five-year equivalent.

A key decision for those looking to refinance is whether to lock in a fixed rate today at about 4 per cent — giving certainty over monthly payments and, for many, peace of mind — or to go for a variable or tracker mortgage. Two-year trackers, which follow Bank of England base rates, currently average around 5 per cent, according to finance site Moneyfacts. So why would a borrower sign up for the more expensive option?

The answer lies in market expectations of headline inflation. If inflation falls faster than expected, this could lead to earlier cuts in base rates and provide more opportunity for lenders to trim their interest rates on fixed- rate mortgages (see below). So fixing for a long period now could leave borrowers paying more than they need in the latter part of their fix — and facing a potentially heavy penalty to end the deal early.

James Christopher, a homeowner near Norwich in his forties, came to the end of his five-year fix — on a rate of 1.9 per cent with Nationwide — in March. He decided to stay with his lender, taking a two-year tracker at 0.24 percentage points above the 4.25 per cent BoE base rate. “This is a short-term gamble on the basis that we can move on to a fix if and when rates fall.” 

An A-level economics teacher, he keeps a close eye on the relevant data. “I check rates weekly because I’m not entirely sure it’s the right decision. We are at the top of our repayment budget and would be immediately better off by £100 or more a month if we moved to a five-year fix . . . However, I am loath to lock this in for such a long period.”

Trackers may allow borrowers to switch out to another deal with no penalty and some will allow overpayments exceeding the annual 10 per cent limit typically enforced on a fixed deal. Barclays offers the lowest rate on a two-year tracker mortgage, at 4.39 per cent with a £999 fee on a loan-to-value ratio of up to 60 per cent, according to Moneyfacts.

Lenders have been competing hard on rates to win new customers as housing market activity has slowed, with mortgage approvals down to 43,000 in February compared with 69,000 in the same month in 2022, according to the BoE. But it is by no means one-way traffic on rates: this week, lenders such as Nationwide raised interest rates on selected fixes.

Chris Sykes, consultant at broker Private Finance, says most of his clients are plumping for five-year fixes, preferring the certainty of fixed monthly payments even if a drop in base rates later brings cheaper alternatives.

Virgin Money currently offers the lowest five-year fix at 3.79 per cent on a loan-to-value ratio of up to 65 per cent and an arrangement fee of £1,495, according to Moneyfacts. The share of five-year fixes among new mortgages ticked up from 49 per cent in December 2021 to 67 per cent at the end of 2022, according to the latest data from the BoE.

He adds that the track-and-fix strategy may also carry extra costs through the fees that can be charged at a later date for refinancing — arrangement, valuation, legal and brokers’ fees. Sykes says: “Once you take into account all of the different costs involved, at what point is it actually saving you money to be on a tracker versus a fix?”

The variable or tracker route is nonetheless one that often appeals to those with the wherewithal to ride out higher rates — higher earners with bigger mortgages, for whom a fixed product or arrangement fee represents a relatively small additional cost. “The clients that are going for trackers are those that generally have a little bit more liquidity. They could afford to take that hit if rates went up. For others that uplift in rates is prohibitive,” Sykes says.

One thing for fans of short-term products to bear in mind is the effect of a fall in house prices. If a borrower takes a tracker for 18 months or opts for a two-year fix, and prices fall by 10 per cent during this period, the loan-to-value ratio of the mortgage will rise. If the LTV started out on the verge of 75 per cent, they could find themselves in a higher LTV bracket on refinancing, and stuck with less attractive rates.

“This is quite a big thing and I’m not sure whether everybody’s factoring it in. If you’re thinking of remortgaging in 18 months time and values have gone down, you might not get the same loan to valuation you had today,” says Adrian Anderson, director at broker Anderson Harris.

Sticking with your lender

Faced with tough choices, more borrowers are choosing to stay with their existing lender, and take up the advantages of a “product transfer”. Moving to a new lender requires borrowers to pass an affordability test and a new valuation of the property, usually incurring a fee; these are waived by their existing lender, unless they are asking to borrow more.

“It’s a lot less hassle to take a product with your existing lender than to start all over again,” says Gammon.

Brokers say rates on product transfer deals are also the same as or very close to those offered to new customers, as lenders are keen to keep customers on their books. But many borrowers may also find that a product transfer is scarcely a matter of choice. As rates have soared, they may be unable to access a mortgage they secured before the pandemic or before the September “mini” Budget — particularly if their circumstances have changed.

“They’re not quite mortgage prisoners, but if they try and get the same mortgage, it might be deemed unaffordable,” says Gammon.

Change the terms 

Lenders may allow customers to move from a repayment mortgage to an interest-only product as a temporary measure to cut monthly payments. They may also let borrowers extend the term length of their loan, from 30 to 35 years, for example. Monthly payments will come down, but the homeowner should be warned they will pay more interest over the life of the mortgage.

Some borrowers are fortunate enough to be able to overpay their mortgage. Brokers say more people have been doing this, as it not only reduces the overall debt but may bring down the loan-to-value ratio on their mortgage. This can open up the better rates and terms offered by lenders to attract lower-risk borrowers with plenty of housing equity.

“If they have cash or investments that aren’t yielding an awful lot, a lot of people are making some quite large overpayments towards their mortgages where they can,” says Sykes.

In particular, he has noticed a drop-off in a long-running trend for higher-earning clients, often receiving a large annual bonus, to use the lump sum for a buy-to-let purchase.

“With those making less sense [for tax and regulatory reasons] people prefer the security of starting to pay down the mortgage on their home because it’s going to cost them more over the next few years. It just looks more and more attractive as a proposition.”

For Gabe Stones and his partner in east London, paying down a large chunk of the mortgage is not an option. Instead, they are minded to stick with their existing lender, Accord, on a five-year fix at 4.13 per cent to minimise monthly outgoings.

But, like many borrowers who now face mortgage rates at levels not seen for over a decade, Stones is struggling to make a decision. “I just saw another headline saying rates are going up in May. I still don’t quite know what to do.”