Variable & fixed rate mortgages explained

It can be hard to decide upon which mortgage is right for you when you want to take out a loan to buy a property. There are quite a few different types of mortgage and each has their own good and bad points.

This guide will examine two types of mortgages - fixed rate and variable rate. Knowing the difference between these two forms of mortgages can help a lot when it comes to making the right decision on which plan you want to sign yourself up to.

The reason this decision is so important is that it directly affects how much you will pay over the entire course of your loan. The amount that you are charged for your loan is referred to as interest. Interest takes the form of a percentage of the total that you owe, charged monthly. The bigger this percentage, the more you will be paying for your loan overall.

This is why it is so important to understand mortgages with different ways of managing your interest rates. The aim of the game is saving money on your mortgage. To do this you need to try and pay the least amount of interest possible over the entirety of your mortgage term. This would be simple enough if you knew exactly what your interest rates were going to be for your whole mortgage. Unfortunately, however, this is not the case. This means that you will have to take a variety of factors into account when deciding upon what mortgage to take out.

Variable rate mortgages

Variable rate mortgages are mortgages that allow fluctuation on the level of interest that you pay per month. This means that some months you may find that you end up paying more than you expect and some months you end up paying less. These types of mortgage generally come in two forms: tracker and standard variable.

Tracker mortgages are fixed to a set percentage above the Bank of England's base rate of interest. This means that the amount you pay on your repayments will generally track the UK's standard rate. It is worth noting that the lender is likely to charge a percentage or two higher than the base rate set by the Bank of England. Some mortgages are known as “discount” tracker mortgages; this means that they will offer you a discount off of their standard tracker rate for a set period of time.

Standard variable rate mortgages can also change over time. They differ from trackers due to the fact that they are not fixed to the base rate of interest set by the Bank of England. With standard variable rate mortgages, the fluctuation of interest rates from month to month is completely decided by the lender. This means that on a standard variable rate mortgage you could actually pay either more or less than you would on another form of mortgage. There really is no way of knowing for sure and for this reason they are considered a bit of a gamble. If the gamble pays off, you could end up saving a lot of money but if it doesn't, you could spend more than you expected.

Fixed rate mortgages

Fixed rate mortgages allow you to set the rate of your interest at a predetermined amount for an agreed upon length of time. This means that the amount you pay per month will remain unaffected by changes to the Bank of England's base rate of interest. It also means that your lender cannot change the rate you pay until the agreed upon period of time is over.

People normally choose fixed rate mortgages because they want to be secure in the knowledge of how much they will need to pay each month. The fact that you know that the interest rate will not change means that you can plan ahead and budget adequately. These fixed rate mortgages remove the chance of you getting caught out by a rise in interest rates and becoming unable to meet your payments if the price goes up.

The downside of choosing a fixed rate mortgage is that it offers you less flexibility when it comes to your financial arrangement with your lender. When you take out a fixed rate mortgage it will normally result in you being locked into the mortgage deal for a set amount of time. This means that early exit fees will apply if you want to move your mortgage somewhere else. These fees can often be huge and are meant to deter people from switching away until the set period is over.

The rate of interest your plan is fixed at is generally worked out by the lender, who will take a number of factors into account. The main factor influencing your fixed rate is the lender's prediction of how interest rates will change over the period of your loan. This prediction is one that normally works in favour of the lender due to their extensive research into market trends. In spite of this, these plans can offer you a great way to manage your budget in advance.

What is better: a fixed rate or variable mortgage?

There is no straight answer to this question. Since 2009 the base rate of interest set by the Bank of England has been continuously dropping to record lows. Financial experts are not expecting them to rise again until 2016 at the earliest. This means that in theory this may be a good time to take out a variable rate mortgage. However, there is still some risk involved because nobody knows exactly what will happen with interest rates after this time. There are some who think that they could rise quite sharply, which would mean that your payments could start getting a lot higher. There are others who think that the increase in interest rates could be much more gradual. This would mean that your payments would not go up that much over time.