I am usually a big fan of long term fixed rate mortgages. Maximise the certainty of payment for as long as you can, nice and boring like your mortgage should be. Also, if you always choose say a five year fixed rate each time throughout a 25 year term, you only need to remortgage four times, whereas if you go for short 2 year fixed rates, you could remortgage (and pay fees!) upto ten times.
There are of course obvious reasons why you would opt for a shorter tie-in period, such as wanting to move home in the near future or an anticipated cash windfall which you can pay off your mortgage balance.
One not so obvious reason to think about opting for a short term fix, is because you are a first time buyer with a relatively high loan-to-value mortgage. This goes somewhat against logic because we usually think of first time buyers as those who have less disposable income than older borrowers do. Although remember we are all individuals and have our own personal circumstances and need to do what works for ourselves, not the general consensus.
The first advantage of a short term fix is that it allows you to get out of the mortgage penalty free sooner, which may be a useful option, especially for couples who are living together for the first time who are more likely to separate than say a couple who have been married for 30 years. It also makes it easier if you want to move house together after a short period of time, which often young couples do.
Another advantage relies on a little bit of luck. If you buy a house with say a 5% deposit, if property prices rise or better still you increase the value of the property significantly by doing works, and at the same time you are paying down your mortgage balance, then you could find that you increase your equity portion quite quickly. The risk here is that property prices can move downwards too and you could find that in two years you are in a negative equity situation and can’t secure a new interest rate.
Lastly, as most mortgages revert to the lenders standard variable rate at the end of the tied in period, regardless of the level of equity you have then the interest rate risk is actually lower for those with less equity. Imagine two borrowers with ABC bank, one with lots of equity and a low interest rate of 2%, and another with very little equity and a high interest rate of 6%. If each of them revert to the lenders standard variable rate when their mortgage deals comes to an end, it is the borrower with lots of equity that will see their mortgage repayments increase the most. In fact, it may even be that the borrower with little equity sees their repayments go down. I’m not saying you should necessarily play the interest rate movement guessing game because even the experts are really bad at that game, but just pointing out that the higher your rate is now, the less risk you have when your deal ends.
Opting for shorter fixed rates can be a risky strategy. This should only be considered by those who have the excess income and can afford to see their mortgage repayments increase if things do go wrong. As always advice should be sought so that you can discuss the potential advantages and drawbacks which will apply to your own situation.
Jason Hinde FPFS, Cert SMP – Chartered Financial Planner
15th February 2016
“