Is a mortgage with a fixed term of five years the best option?

• Last year saw a sharp increase in biennial fixes as people expected interest rates to fall
• But this year’s interest rate stalemate means five-year rates are back in favor
• Just as many people fixate for five years as for two years, says real estate agent

Those buying a home or taking out a new mortgage now face a difficult choice when deciding how long to lock in their mortgage rate.

Last year, most borrowers chose to secure the loan for two years. They believed that interest rates would start to fall during that period, and that a shorter period would allow them to move to a cheaper rate more quickly.

However, confidence that interest rates will soon fall drastically seems to be disappearing, which means that more and more people are now choosing to fix their interest rate for five years, according to mortgage broker L&C.

What happens to the mortgage interest?

Mortgage rates have been gradually rising since early February, which is the opposite of what most people expected in early 2024.

In January, financial markets predicted that the Bank of England would start cutting the base interest rate, which affects mortgage prices, from March.

However, disappointing inflation figures, both here and in the US, have caused the Bank of England to hold interest rates for longer than expected.

Now the general consensus is that the first cut in the base rate will take place in August – six months later than previously planned.

As a result, rather than falling, the cheapest fixed mortgage rates have actually risen by roughly 0.5 percentage points since January, with lenders adopting a ‘higher for longer’ scenario for rates.

According to Moneyfacts, the average five-year fixed rate is about 0.43 basis points lower than its two-year counterpart.

The lowest five-year fix on the market is currently 4.28 per cent, with a £999 fee, from Santander, while Halifax offers the lowest two-year fix at 4.78 per cent, with a £1,099 fee. Both deals are aimed at buyers rather than remortgaging homeowners.

Someone with a £200,000 mortgage paid off over 25 years would save themselves £57 a month by choosing the cheapest five-year option.

What do mortgage lenders do?

David Hollingworth, associate director at L&C Mortgages, says the split between those taking out two- and five-year deals is about 50:50.

“The fact that interest rates are still forecast to decline over time continues to divide product usage among those who choose to hold for a few years over a longer period,” says he.

‘We have seen a slight shift from a two-year fixation to a more even distribution in the share opting for a two- or five-year fixation.

‘Now that the market has stabilized, the appeal of lower five-year rates may generate more interest, especially since no one knows how low rates will actually fall.

He added: ‘The base rate is still expected to fall this year, but that has continued to shift, both in terms of timing and how steep the fall could be.

“Nevertheless, it may make borrowers unsure about whether to take out a loan at a time when interest rates are higher.”

Should you fix your mortgage for five years?

The obvious reason to make a five-year repair is that it is almost always cheaper to do so at the moment.

But for most people, it’s less about the initial savings now and more about the direction of interest rates in the long term.

Nobody wants to commit to a five-year fixed interest rate of 5 percent in 2024, only to find out that they could have taken out a new mortgage at an interest rate of 3 percent in 2026 if they had opted for a two-year fixed interest rate period instead.

The market-implied path for the base rate in the Bank of England’s May Monetary Policy Report is that it will fall from 5.25 percent to around 3.75 percent by the end of 2026.

It is worth pointing out that this forecast has increased by 0.7 percentage points on average, compared to the corresponding period in the February report.

What are mortgage interest rate predictions based on?

Lenders’ fixed-rate mortgage prices are largely determined by Sonia swap rates.

Mortgage lenders enter into interest rate swap agreements to protect themselves against the interest rate risk associated with providing fixed-rate mortgages.

The rates they pay for this, also called swap rates, show what lenders think the future has in store for fixed interest rates.

On June 11, the five-year swaps were 4.09 percent and the two-year swaps were 4.62 percent, both below the current base rate.

“It’s important to remember that fixed mortgage rates appear to predict the movement of interest rates,” says David Hollingworth of L&C.

‘The result is that the current fixed rates price in a lower base interest rate in the current market expectations.

“That’s why fixed rates are lower than variable rate options, and also why fixed rates can move up and down despite the fact that the base rate has yet to move in the first place.”

When could mortgage rates fall?

Hollingworth says fixed mortgage rates will only fall significantly if future interest rate expectations fall further in the coming months and years.

He added: “Many economists believe that the base rate will continue to fall and the implied path seems to indicate that the base rate could fall to 3.75 percent in 2026.

However, that marks an upward shift in recent months, and none of this can be guaranteed.

‘Even then, the fixed rates offered at that time will depend heavily on where rates are expected to go next.

“If potential increases are on the way, fixed pricing may not be far away from where we are now. If a further downward trend is expected, fixed rates may price in lower rates.”

Peter Stimson, head of product at MPowered Mortgages, agrees that the future direction of mortgage rates is difficult to predict, although he is confident mortgage rates are unlikely to rise from here.

“We think mortgage rates are at their peak now,” Stimson says.

‘However, this should not mean that consumers can expect mortgage rates to fall immediately if the Bank of England cuts rates.

‘Many of the assumed reductions have already been incorporated into the pricing of the forward interest rate.

‘How much interest rates will fall will therefore largely depend on the extent to which inflation falls in the coming months and on the size and timing of any interest rate cuts by the Bank of England.

‘While we hope that mortgage rates have finally reached their peak, if this year has taught everyone one thing, it’s that there are no guarantees when it comes to predicting what will happen next with mortgage rates.’

One thing most commentators and experts agree on is that mortgage rates will not return to their pre-2022 lows, when borrowers with the most equity could secure interest rates below 1 percent.

“We certainly don’t see a return to the decade-long low interest rate period from 2010 to 2021,” Stimson said.

‘Longer term, we think Bank of England interest rates are likely to remain roughly around 4 per cent, but there could be divergence between the two sides depending on what happens to the economy as a whole.’

If Stimson, among others, is right and interest rates end up around 4 percent or even slightly lower, it is unlikely that we will also see much change in the field of fixed mortgage rates.

Before the rapid increase in the base rate between December 2021 and August 2023, the lowest mortgage interest rate was above the base rate. That was the case between 2008 and 2022.

This means that even if the base rate remains around 4 percent, we can expect mortgage rates to be higher unless there is reason to believe that rates will fall further.

What should mortgage lenders take into account?

Ultimately, choosing what length to commit to depends on what one thinks will happen to interest rates during that time.

It will also depend on their personal circumstances. If someone thinks they will have to move within five years, a five-year solution is not ideal as there would normally be a fee to end the deal early.

Those who opt for a two-year fix are essentially hedging their bets on a drop in interest rates over the next few years.

They will rely on the expectation that once inflation has fully subsided, interest rates will fall.

They are willing to put up with the higher rates for two years, hoping that the rate they then switch to will ultimately earn them more than if they had simply opted for a five-year fix.

Those who opt for a five-year fix will save in the short term and gain certainty about what their payments will be for much longer.

There are also other options for borrowers. They can get a two-year tracker that follows the Bank of England’s base rate.

Although currently more expensive than fixed rate deals, a tracker mortgage with no early repayment charges could put borrowers in a position to benefit from base rate cuts.

There are also three-year and even ten-year solutions that can be considered.

Hollingworth added: “We are seeing a rise in three-year interest rates, which could provide a balance for those who feel two years could be over too quickly but are still keen to review sooner rather than over five years.

‘It has also not taken into account what could change and external factors will clearly make a big difference to the interest rate outlook over time.

“Rather than trying to predict what might happen, borrowers should know what works best for them.

‘Those who will remain in their property for a longer period may want to lock in the interest rate for five years or more and should not turn down the option.

‘Those hoping that interest rates will fall can clearly take a shorter-term view, but should consider their position if things change and whether they are able to cope with higher rates and payments.’