MSE’s Academy of Money
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1.3 Fixed-rate or variable rate?

It is now time to make the decision about your mortgage – should you go for a fixed-rate or a variable rate mortgage product? Over the typical 25-year life of a mortgage this is a decision you may choose to make several times, switching from fixed-rate to variable or vice versa as you seek out the product that is best for you each time.

Watch Video 2 and explore the different interest rate features of mortgages, the fees that are associated with them and the pros and cons of different products. You will see that variable rate products take a number of slightly different forms.

Once you have watched the video, there are a couple of questions for you to answer below.

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Video 2 Understanding mortgages
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Activity 3 Fixed-rate mortgages: benefits and risks

Timing: Allow approximately 5 minutes

What are the pros and cons of fixed-rate mortgages?

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Discussion

Fixed-rate mortgages provide certainty about your monthly mortgage payments as these will not rise during the fixed-rate term. They are a sensible choice for households on tight budgets with only a limited capacity to afford an increase in the costs of a mortgage, or for those who simply prefer certainty about what their mortgage will cost.

Note that these fixed-rate products are commonly for 2 to 5 year terms, with a limited market for 10 year fixed-rate terms. Fixed-rate terms for longer periods have never caught on in the UK. So the likelihood is that any fixed-rate deal will only cover the first part of your mortgage term, and not the full term, unless you’re in the final years of a mortgage and remortgaging for the last time.

Fixed-rate mortgages often come with the cost of an upfront ‘arrangement’ fee (though this is true of trackers and discount mortgages too). Those on fixed-rate mortgages do not benefit from falling interest rates. Also, usually you will have to pay an early repayment charge if you repay the mortgage before the end of its fixed-rate term. At the end of the fixed-rate term the mortgage will normally revert to the lender’s standard variable rate unless action is taken to move to an alternative mortgage product.

What are the pros and cons of variable rate mortgages (including ‘trackers’ and ‘discount mortgages’)?

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Discussion

Variable rate mortgages will move up or down as interest rates in the economy alter – specifically when the Bank of England moves its ‘Bank Rate’. Those with these mortgages benefit when interest rates fall and lose out when rates rise. This lack of certainty can cause problems with household budgets. On the other hand, there are normally no early repayment fees if you repay your mortgage early.

OK, it’s time for a short quiz to check how much you have learned so far. The section after that will look at the other options which may be available to you to customise your mortgage product.

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