Fixed-rate mortgage or tracker? How to tackle rising interest rates

Fixed-rate mortgage or tracker? How to tackle rising interest rates
Fixed-rate mortgage or tracker? How to tackle rising interest rates

Mortgage borrowers will be spared from today’s interest rates rise by an escalating price war between lenders – if they know where to look.

The Bank of England increased interest rates by 0.25 percentage points to 4.25pc today as it scrambles to control double-digit inflation, which rose again in February.

Many households have been biding their time on tracker rates, pegged to central interest rates, as fixed-rate deals soared in price at the end of last year.

But fixed rates have since fallen and experts are advising it may make sense for many to lock in, giving families the chance to cap soaring repayments. The cheapest fixed-price deals are already well below the typical tracker mortgage.

Trackers were priced significantly lower than the average fixed-rate mortgage during the economic fallout which followed the mini-Budget last year.

When mortgage rates peaked in mid-November the average two-year fix was priced at 6.65pc, while the average two-year tracker rate was 3.77pc – an interest saving of £360 each month on a £150,000 loan.

Homeowners piled in and there are now thought to be as many as 1.6 million households on variable rates.

But savings have shrunk as fixed rates have steadily dropped and the cost of trackers rose in line with the Bank Rate.

While this week’s rise will be passed on almost immediately to borrowers on tracker mortgages and some on variable deals, lenders will have already priced the increase into their fixed rates, according to brokers.

Chris Sykes, of broker Private Finance, said the price war between lenders meant today’s 0.25 percentage point interest rate rise was unlikely to feed through to new fixed mortgage rates.

Mr Sykes said: “Most lenders would have anticipated a rise between 0.25 and 0.5 percentage points today and have already factored it in, so we don’t expect them to act on a reactive basis following today’s announcement.”

The pricing of fixed mortgages are also dictated by "swap" rates, a market indicator used by banks and building societies to gauge future borrowing costs, which have dropped significantly in recent weeks due to turmoil in the banking sector.

Graham Cox of Self Employed Mortgage Hub, a broker, said: “The difference between fixed-rate deals and trackers has fallen markedly in recent weeks, to the point where a lot of trackers aren't worth the gamble.

“I think current interest rates will be the new normal for the foreseeable future, maybe they will get fractionally cheaper but there is no guarantee.”

On Thursday, the average two-year fixed rate was 5.31pc, according to analyst Moneyfacts, and the typical two-year tracker priced at 4.83pc. A borrower with a £200,000 loan could save £80 a month in interest by opting for the tracker.

But the cost of a tracker will rise further in the coming days as lenders feed through the Bank of England rise. If the average tracker rate rose by the full 0.25 percentage point increase, to 5.08pc, the saving on the same loan would shrink to £38 a month.

For many, this saving will no longer outweigh the potential risks of a tracker deal. There is no ceiling on how high repayments could rise and their volatile nature means tracker mortgages are not appropriate for households that prize certainty over savings.

Hannah Bashford, of broker Model Financial Solutions, said: “Clients who had chosen tracker rates before Christmas are now re-visiting their options, because the gap between trackers and fixed rates has shrunk, especially for people with a bigger deposit.

“The general consensus from our clients is that they would like security of a fixed rate for the next couple of years.”

Where can I find the best deal?

There is an escalating price war between lenders who are competing for business to hit lending targets.

The average two-year fixed rate has fallen from 5.79pc to 5.31pc since the beginning of January, while the typical five-year rate has dropped from 5.63pc to 4.96pc, according to Moneyfacts.

But the cheapest deals have fallen even further, some dipping below 4pc.

The cheapest two-year fixed rate for a borrower remortgaging can be found with Cumberland Building Society at 4.29pc. Borrowers will need a 40pc deposit and must pay a £999 fee, according to analysis by L&C Mortgages.

For borrowers taking out a new mortgage, the cheapest two-year deal is with Nationwide at 5.44pc with a 5pc deposit and £999 fee.

The cheapest five-year fixed rate for a borrower remortgaging is with First Direct at a rate of 3.99pc. Borrowers will need at least a 40pc deposit and must pay a fee of £490.

For borrowers taking out a new deal and wanting to fix for five years, the lowest rate is 4.99pc with Newcastle Building Society with no fee and £250 cash back.

It is important to remember that the lowest interest rates do not necessarily equate to the best deal. High fees can sometimes outweigh marginal savings on similarly priced interest rates.

How long should I fix for?

The cost of borrowing this year will remain inflated despite interest rate falls, serving as a shock for households coming off rates fixed two or five years ago. More than 1.4 million borrowers will pay higher rates this year as their fixed deal comes to an end, according to figures published by the Office for National Statistics.

Capital Economics forecasts the Bank Rate to peak at 4.5pc and remain there until the end of the year. It expected the average mortgage rate to ease marginally from 4.9pc today to 4.8pc by December.

But the biggest falls will come in 2024, when the Bank Rate is forecast to drop to 3pc by the end of the year and average mortgage rate will fall to 4pc.

Brokers suggest the typical borrower should fix for two years and make the most of lower rates in 2025, although how long each household fixes will depend on their individual financial circumstances.

Mr Fish said: “Once fixed rates become cheaper than trackers we will shift our attention to two-year fixes, so that clients aren’t paying over the odds for the next five years.”

Samuel Mather-Holgate, of broker Mather and Murray Financial, said: “The longer you fix for, with rates where they currently are, the longer you lock in potential losses for.

“As a middle option, fixing for two years will be roughly cost neutral as rates go over the hump and you can then reassess after 24 months.”