What Is A Fixed Rate Mortgage?
A fixed rate mortgage is quite simple to understand, because it is one of those financial products that does what it says on the tin!
Firstly, it is a mortgage - a type of loan for those who are buying a house. So far, so good. And it is fixed rate. That is, it is not variable rate.
Now we think of the word fixed as meaning unchanging, and indeed that is an accurate description here - the rate doesn't change, it stays the same. As opposed to a variable rate mortgage, where the rate can change.
So the last thing to understand is that word rate - what is it referring to? Well, it is just the interest rate that is paid on the mortgage.
Thus if you get a fixed rate mortgage and the interest rate agreed is 3%, then you know the rate is going to stay at that level for the agreed period, as opposed to a variable rate mortgage where it could move either higher or lower.
The main reason that people like a fixed rate mortgage is because of the certainty that it brings to them.
When you have a variable rate mortgage, you don't know for sure what you are going to have to pay month to month, as if the Bank of England changes its base rate, then the interest rate on your mortgage may well change too. And although it often moves by as little as just 0.25%, which doesn't sound like much (and is cryptically referred to by many commentators as 'a quarter of one per cent'), when that is applied to such a large capital sum as many mortgages, it can be considerable indeed.
Contrast that then with the fixed rate mortgage - here you don't need to worry about whether interest rates are going up and down elsewhere, because yours is fixed.
This means that you can plan your budget exactly: because of this fixed, rather than variable, cost.
So why doesn't everyone just get a fixed rate mortgage due to this benefit? Well, partly because they often work out as more expensive overall than variable rate mortgages.
Banks know that if the interest rate goes up, then they can't charge you more, so they could end up losing out on some mortgages. Therefore they price them to cover this eventuality, which typically means that they have a higher starting interest rate than a variable product.
Which in turn doesn't mean they are worse, because if interest rates rise, then the fixed rate mortgage someone is on may then have a more attractive rate than those on a mortgage that is variable that experience the pro rata rise in their interest rate.
On the flip side, if interest rates fall, then those on the fixed rate don't benefit - so if market conditions were such that interest rates fall appreciably over the course of a year or two, then that would be bad news for someone on a fixed rate deal.
In summary, a fixed rate mortgage is easy to understand, and with the consistency of rate it means that it can be easier to plan your finances around than other mortgage products. And, as with anything, there are advantages and drawbacks with this product type relative to other mortgage products.Last update: 01 Jun 2015
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- Buying a new build
- What is a Buy To Let Mortgage?
- How Does Interest on a Mortgage Work?