2-year or 5-year fixed mortgage in the UK?
February 24, 2014 12:02 PM   Subscribe

We've received conflicting advice from two mortgage advisers, and I'd like to get some more opinions.

The first adviser suggested that if we could afford a 5-year fixed mortgage (which we can) then we should go for it because of the increased stability.

The second adviser suggested that a 2-year fixed mortgage would be a better idea. His suggestion was that in two years the interest rate would not have changed very much (if at all) and the price of the house would have gone up. Because we have a 20% deposit our loan-to-value ratio would have gone below 75% and we'd have cheaper options for the renegotiated next "term" of the mortgage.

Your thoughts, Mefi?

YANAL, etc.
posted by alby to Work & Money (16 answers total) 1 user marked this as a favorite
The difficulty with both scenarios is that nobody knows how interest rates will change in the next few years. You might find in two years' time (if you go for the 2-year fix) that at the end of that time base rate night have risen from its current 0.5%, and along with it the cost of borrowing will also have increased. So even though your LTV will be lower, you might not be better off if the available mortgage deals are more expensive due to interest rate rises.

Or you could tie in for five years, with the knowledge that your payments will be stable over that period, but kicking yourself after two years when you see what deals you could have got if only you'd fixed for two years.

It all comes down to whether or not you're prepared to gamble on interest rates and whether cheaper mortgages will available in two years' time, or if you prefer (as most people who go for a five-year fix do) the stability of payments over that period.

All the financial commentators seem to think that the Bank of England will keep base rate at 0.5% for at least the next 12 months, and then any rise will be gradual. So it's more likely than not that the 2-year deal will turn out to be a better buy.

But also remember to factor in the cost of switching to a new product at the end of the fixed-rate period. Even if you stick with your current lender and just switch to a new product, there'll be application fees and possibly a re-valuation of the property if you want something with a lower LTV. If you switch to a new lender, there'll be product fees and legal costs. The more attractive the mortgage, the higher the product fee; some lenders charge a fee of £2,000 for the most attractive interest rate.
posted by essexjan at 12:17 PM on February 24, 2014 [2 favorites]

Unless things are vastly different in the UK, what this guy means is that you'd get a new mortgage at the end of your fixed term.

Which means you'd go through closing again, and pay closing costs again. Assuming your house does gain in value (REALLY BIG ASSUMPTION) and also assuming interest rates don't rise (FAIRLY LARGE ASSUMPTION) you'd stand a chance to wipe out that gain by paying closing costs all over again in 2 years! And then be stuck with a higher rate for the next 10-30 years!

Yes this closing cost wouldn't come out of your pocket, it would come from the equity on your home, and then you stack that cost into the principle of the new mortgage. This is penny wise, pound foolish.

The only way this makes sense for you is if you don't plan on staying in this house past 5 years or are willing to go through closing again and risk higher rates in the future. Oh, and rates for re-fi are different (usually higher) from purchase rates too.
posted by fontophilic at 12:18 PM on February 24, 2014

It's unlikely that interest rates will stay at the current level for much longer than perhaps this year. Nothing is certain in this world though, including future house values. Work out your monthly payments on the 5% fixed, then do the same on the 2 year fix, determine if you prefer the certainty of the longer fix or whether you'd prefer the cheaper 2 year deal that has the gamble attached. Will you be able to afford the mortgage if the best deals were 1% higher? How about 3% higher or more?
Plenty of calculators to help illustrate these scenarios.
And food for thought is here.
Mind you, I'd find exceptional hikes the interest rates unlikely given that take-home pay is still so depressed (and depressing) for many!
posted by razzman at 12:20 PM on February 24, 2014

Unless things are vastly different in the UK

I think they are, yes. Refinancing every 2-5 years is fairly standard, at least I think it is - that's the impression I've got so far.
posted by alby at 12:23 PM on February 24, 2014

fontophilic, things are vastly different in the UK.

Our mortgages are generally 20-25 years, with the first few years on a particular product which is either a fixed rate for a particular period or which tracks a rate for a period. The fix/trackers are typically for 2-5 years.

At the end of the fixed/tracker period, the borrowers have the option of reverting to the lender's standard variable rate for the remaining 22 years of the mortgage, or else transfer to a new product for another 2-5 years. Because the SVR is usually an unattractive rate, it makes sense to choose a new product offered by the lender.

So, the mortgage might be a 25 year term of which the first 3 years are on a fixed rate. At the end of 3 years, the borrowers would transfer to a new product - say a 4-year fixed rate, and at the end of those 4 years, choose a different product, and so on.

The mortgage would only be repaid and closed if the lender didn't offer a suitable product and the borrowers decided to re-mortgage with a different lender.
posted by essexjan at 12:25 PM on February 24, 2014 [1 favorite]

this is actually a math problem. How much more are you paying for the five vs the two, what are the odds rates in year 3 are higher than they are today - and most importantly can you afford that. Can you afford 200 bps higher? 400 bps higher? What is your tolerance? What's the biggest two year move in UK mortgage rates since WWII? What if home prices decline and the LTV goes up? How much more will I have to pay? Is this loan amortizing? Even if it is how much home appreciation do I need to hit the lower LTV benchmarks?

I personally at low rates would rather sell someone interest rate risk - take the longest fixed rate I could find. I might be wrong, but if I am - so what - its like paying an insurance premium for a storm that never comes. It would suck to take a two year fixed rate, see rates good up 4% and see home prices decline.
posted by JPD at 12:40 PM on February 24, 2014 [1 favorite]

One thing you should also consider is this: if you opt for the 2-year fix, during that time the bank may change its lending criteria and you'll find you no longer qualify for a good deal at the end of the period. (This could also happen after a five-year fix but the longer period involved means there's more of a buffer in place.)

This has happened in recent years so people who took out a fix a few years ago are now finding that their bank's changed its policy on how much it will lend. Or it's decided it doesn't want to lend on certain types of property. Or it's changed its LTV ratios. Or it no longer wants to lend to people in certain employment categories. Their only options are to revert to the lender's standard variable rate, or to remortgage to a new lender - if they satisfy another lender's criteria - which involves fees and legal costs.

So although the borrowers' circumstances haven't changed, the factors the lender will take into account when deciding whether to offer a new product has changed. It's all to do with the risk to which the lender has decided it wants to be exposed, rather than anything borrowers have or haven't done.

This has been a particular problem for people who previously had an interest-only mortgage fixed for 5 years, who now want to fix again. But lenders are now no longer offering interest-only mortgages, unless the borrower is able to show there's some kind of repayment vehicle in place (e.g. ISAs, savings plan, etc). Previously lenders had been happy to go along with allowing interest-only mortgages because, well, prices were skyrocketing and could never go down, right? Wrong.

The crash in 2007 meant that lenders had to take a far more cautious approach to lending. This is starting to be relaxed - slightly - but you shouldn't assume that at the end of a fixed-rate period you'll qualify for another product from your lender. Chances are that if you're in solid employment and every payment's been made on the dot, you won't have a problem, but if you're self-employed or change jobs regularly, this might affect a future lending decision.
posted by essexjan at 12:59 PM on February 24, 2014 [1 favorite]

His suggestion was that in two years the interest rate would not have changed very much (if at all) and the price of the house would have gone up.

While the BoE is independent, there is a general election due in May 2015 which will change the political climate to some degree.

It's definitely a risk vs. reward question, factoring in your personal tolerance of risk, a sense of where your house and local market fit on the UK's property insanity curve, and your ability to cope with possible wobbliness on all sides a couple of years from now.
posted by holgate at 1:03 PM on February 24, 2014

A UK mortgage adviser has a vested interest in getting you to take a short term fixed rate mortgage, because you're likely to come back at the end of the term and pay them a whole new set of fees for arranging a new mortgage.

A fixed interest rate mortgage is effectively an interest rate swap bundled with a variable rate mortgage. There's a reasonable arguemnt that you may as well take out the cheaper floating rate mortgage and pocket the difference, saving the cost of the interest rate swap to cover any interest rate rises over the course of the fixed rate that you would otherwise have taken out.

If interest rates rise much more than the market is expecting, then this will cost you of course. You have to weigh up how much you're willing to pay for insurance against interest rate rises vs the expected savings.
posted by pharm at 1:04 PM on February 24, 2014

Do you want to worry about mortgage rates 2 years from now, or start worrying in 5 years?
posted by blue_beetle at 1:06 PM on February 24, 2014

What are the rates? We're paying 1% above the ECB prime, and I don't think it's going to get lower than that, so if the rate is low I'd fix the 5 year myself.
posted by DarlingBri at 1:08 PM on February 24, 2014

Been in this situation twice. Swings and roundabouts to both options. If you think it is unlikely that you will want to sell and move in the five years, then go for the five year option and relax about this for a good few years. You know where you stand for half a decade, and can fiscally project ahead. You'll have a better idea of career, family, incomes, whether the community is a long-term home. You will have built up, possibly, some savings that can come into play. And it's more likely than less likely - so long as your house isn't one of those under several feet of water of late - that it's value will have gone up, rather than down (brute supply vs demand), which also puts you in a better position.
posted by Wordshore at 1:26 PM on February 24, 2014

I agree with the advice above, but there are circumstances in which the shorter fix (or even a tracker) could make sense - mainly if you are just over the LTV requirement to get a better rate and you're confident that you can get below the level in a short period of time.
posted by patricio at 2:20 PM on February 24, 2014

By reading the comments here, you'd get the impression that unless you cross a LTV threshold or you think the BoE interest rate is going to drop then 5 year fixed is the way to go.

I'm on a 2 year fixed due to change in six months time. Even though I won't cross any LTV threshold and the BoE base rate has remained unchanged since March 2009, a quick look on MoneySupermarket suggests I can get a mortgage right now for 0.5% better than what I currently have.

That, for me, results in either a saving of about £100 per month or (if I keep my payments the same) about 4 years off my loan term.
posted by mr_silver at 7:35 AM on February 25, 2014

it doesn't take a big move in rates for that 100GBP to go away real real fast.
posted by JPD at 9:02 AM on February 25, 2014 [1 favorite]

True. It's the risk you take but my point was more that you still have the chance (at the moment) when switching mortgages to save some money - even if you don't cross any LTV threshold.

It's also worth noting that many (but not all) mortgages can be portable. So if you do take one out for 5 years, you can transfer it to a new home you buy several years down the line.
posted by mr_silver at 9:37 AM on February 25, 2014

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