Why choose a variable rate mortgage now?

The rising interest rate environment has provided a significant impetus to borrowers to remortgage and secure a fixed rate before rates rise further. However, after continuous rate increases by lenders in response to five consecutive base rate rises, the average 2- and 5-year fixed deals now appear relatively high compared to variable options and opens a discussion about whether borrowers should now be considering a variable rate mortgage.

The difference between fixed and variable rate mortgages

The main benefit of a fixed rate mortgage is the certainty. The monthly mortgage payments will always be the same for the length of the product, regardless of interest rate movements, however, you will usually have to pay an early repayment charge (ERC) if you leave the product early. Discounted variable rates fluctuate depending on the wider economic and financial market.

The discussion around fixed and variable rate mortgages differ for the residential and buy-to-let (BTL) market.

Why choose a fixed or a variable rate for a residential mortgage?

For a residential mortgage, there are several factors to consider when choosing between a fixed rate and variable rate mortgage.

The main benefit of a variable rate mortgage is that the borrower may be able to reduce their total mortgage payments if the rate remains low for a substantial period of time compared to a fixed rate mortgage. However, a variable rate is a riskier option as the rate fluctuates, and thus many borrowers prefer the certainty of a fixed monthly mortgage payment. Some lenders also offer benefits for choosing a longer-term fixed rate mortgage. If all borrowing is on a 5-year fixed rate or greater, some lenders stress at a lower rate and may lend more.

Choosing to fix your mortgage or opt for a variable rate is an important decision. A mortgage consultant will consider your individual circumstances, deposit and borrowing required. They can recommend the best deal for your circumstances and understand which lenders can help you achieve the level of borrowing you require.

Why choose a variable rate mortgage for my buy-to-let investment?

In the BTL market, potential rental income is considered when assessing borrowing. Lenders carry out a stress test for fixed and variable rates to work out the maximum borrowing. Since the PRA started regulating BTLs in 2017 the standard stressed interest rate is 5.5%, however, there is an exemption for fixed rates of five years or longer.  Some lenders will stress five-year fixed mortgages at 4.5%, some at an initial pay rate. The lower the stress rate used by the lender, the higher the borrowing an investor can achieve for a given rental income. Lenders usually look for a projected rental return to cover 145% of the stressed interest rate. However, there are also exceptions with some lenders for limited companies or lower rate taxpayers.

Choosing a fixed rate or variable rate for your BTL mortgage is therefore not just about your expectation of rates, security and flexibility required, but also the borrowing level required.  The decision of whether to fix your mortgage rate or opt for a variable rate is a complex one and a decision not to be taken lightly. If you are a landlord or would like to know more about how much you can borrow with a variable or fixed rate mortgage for your buy-to-let investment, our consultants can help you calculate the numbers, considering your individual circumstances. Additionally, our buy-to-let mortgage calculators can help you understand your monthly mortgage payments.

The best mortgage rates today

In the residential market, variable rates do appear relatively low at the moment compared to fixed rates, with a difference in rate close to 1.15%. In the buy-to-let market, this gap is slightly larger, however as explained previously, a lower rate may actually result in less borrowing. You can find out more about the best available mortgage rates in our best buys.

To illustrate why fixed rates have increased so much, 2 year SONIA swaps are currently 2.559% compared to 0.224% this time last year, and 5-year swaps are now 2.292% compared to 0.404% last year*. Swap rates guide market expectations and mortgage lenders, and with these large increases, no mortgage lender wants to be caught offering rates below the rest of the market, which would possibly inundate themselves with applications they cannot accommodate or perhaps be unprofitable.

Are variable rates worth considering?

Further increases to the base rate are on the horizon and could possibly reach 2% by the end of the year. Greater than expected increases to the base rate could push mortgage rates significantly higher, making a fixed rate deal all the more attractive. On the other hand, we may find that inflation settles down over the next two years, possibly leading to some lenders reducing their rates. If this is the case, taking a 5-year fixed deal now could mean you are locked in at a higher rate above the tracker rate in 2 to 3 years once inflationary pressures cool off.

Right now, variable rates do appear relatively low and if there is a substantial difference between the discounted variable rate compared to a fixed rate deal and the ERCs aren’t significant, it may be worth considering this option. Choosing a variable rate is a riskier option and may not be suited to the risk-averse individual. While it may be the case that the payments are reduced by choosing a variable rate, there is also the risk of paying more overall if the variable rate remains high for a long period.

If you’re coming to the end of your current mortgage deal or taking out a new mortgage, our experienced consultants can help you understand your options, taking into account your individual circumstances, deposit, monthly mortgage repayments, and help you make informed financial decisions.

Find out more about the Private Finance Experience here.

Please remember that your home may be repossessed if you do not keep up repayments on your mortgage. 

*2-year and 5-year Sonia swaps correct on 25th July 2022.

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