Is a five-year fixed mortgage the best option now that interest rates will stay higher for longer?

• Two-year fixes rose last year as people expected interest rates to fall
• But stagnant interest rates this year mean five-year fixes are back in favor
• The same number of people fix for five years as for two years, says the broker

Those buying a home or remortgaging now have a difficult task when deciding how long to lock in their mortgage rate.

Last year, most borrowers opted for a two-year fixation. They believed that interest rates would start to fall during that time and the shorter fix would allow them to switch to a cheaper rate more quickly.

But confidence that rates will drop drastically anytime soon appears to be waning, according to mortgage broker L&C, meaning more people are now opting to lock in their rate for five years.

What is happening to mortgage rates?

Mortgage rates have been rising steadily since early February, the opposite of what most people expected at the start of 2024.

In January, financial markets predicted that the Bank of England would start cutting the key rate from March, which has an impact on mortgage prices.

However, disappointing inflation data here and in the US has caused the Bank of England to hold rates longer than expected.

There is now general agreement that the first cut in the base rate will come in August – six months later than originally thought.

As a result, rather than falling, the cheapest fixed mortgage rates have actually risen by around 0.5 percentage point since January, with lenders pricing rates under a “higher for longer” scenario.

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

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 of these deals are aimed at buyers rather than home owner remortgage.

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

What do mortgage borrowers do?

David Hollingworth, associate director at L&C Mortgages, says the split between those fixing for two and five years is roughly 50:50.

“The fact that interest rates are still expected to decline over time continues to see the product split between those who choose to lock in for a few years over a longer time frame,” he says.

“We have seen a slight shift back from the two-year fix to a more even distribution of the proportion opting for a two- or five-year fix.

“As the market has stabilized, the appeal of lower five-year rates may attract more interest, especially since no one knows how low rates can actually go.

He added: “The key interest rate is still expected to come down this year, but that continues to shift both in terms of the timing and the steepness of the decline.

“However, it can make borrowers undecided about whether they can lock in at a time when rates are higher.”

Should you fix your mortgage for five years?

The obvious incentive for a five-year fix is ​​that it’s almost always cheaper these days.

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

No one wants to lock into a five-year 5 per cent rate fix in 2024, only to find out they could switch their mortgage to a 3 per cent rate in 2026 if they opted for a two-year fix instead.

The market-indicated path for the key rate in the Bank of England’s May monetary policy report is for it to fall from 5.25 percent to around 3.75 percent by the end of 2026.

It is worth noting that this forecast increased by an average of 0.7 percentage points compared to the equivalent period in the February report.

What are mortgage rate forecasts based on?

Lenders’ fixed rate mortgage prices are largely driven by Sonia’s swap rates.

Mortgage lenders enter into interest rate “swap” agreements to protect themselves from the interest rate risk associated with fixed-rate mortgage lending.

The rates they pay for it, known as swap rates, show what lenders think the future holds for fixed rates.

As of June 11, five-year swaps were at 4.09 percent and two-year swaps were at 4.62 percent — both trending below the current prime rate.

“It’s important to remember that fixed mortgage rates are a predictor of interest rate developments,” says L&C’s David Hollingworth.

“As a result, the fixed rates currently on offer are in line with the current market expectation for a lower base rate.

“That’s why fixed rates are lower than variable rate options, and why fixed rates can move up and down even though the base rate hasn’t changed at all yet.”

When might mortgage rates fall?

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

He adds: “Many economists believe that the prime rate will continue to fall, and the projected developments suggest that the prime rate could fall to 3.75 percent in 2026.

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

“Even then, the fixed rates offered at that time will largely depend on where rates are expected to go from.

“If there is a potential increase down the road, then fixed rate prices may not be far from where we are now. If further downward movement is expected, then fixed rates may have lower rates.”

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

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

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

“A large part of the expected cuts has already been factored into the pricing of forward interest rates.

“So how much rates fall will really depend very much on how much inflation falls in the coming months and the scale and timing of the Bank of England’s rate cuts.

“While we hope that mortgage rates have now finally peaked, 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 pre-2022 lows, when borrowers with the most capital were able to secure rates below 1 percent.

“We certainly don’t see any return to the 10-year period of low interest rates from 2010 to 2021,” Stimson says.

“Longer term, we think Bank of England rates are likely to settle around 4 per cent, but there may be a margin on either side depending on what happens to the economy as a whole.”

If, among other things, Stimson is right and interest rates do settle around 4 percent or even a bit lower, then we’re unlikely to see much change when it comes to fixed mortgage rates.

Prior to the rapid increase in the prime rate between December 2021 and August 2023, the lowest mortgage rates were above the prime rate. This was the case between 2008 and 2022.

This means that even if the prime rate stabilizes around 4 percent, we should expect mortgage rates to go higher unless there is reason to believe that rates will fall further.

What does the mortgage borrower need to consider?

Ultimately, the choice of the length of the fixation 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’ll need to move in less than five years, a five-year fix isn’t ideal because there are usually fees to close the deal early.

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

They will rely on the expectation that interest rates will fall once inflation has died down completely.

They are prepared to put up with higher rates for two years in the hope that the rate they move to after that will end up saving them more than if they had opted purely 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 a much longer period of time.

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

Although they are currently more expensive than fixed rate deals, a tracker mortgage with no early repayment charge could put borrowers in a position to take advantage of a prime rate cut.

There are also three-year fixes and even ten-year fixes that could be considered.

Hollingworth adds: “We may see an increase in three-year fixed rates, which may strike a balance for those who feel that two years might go by too quickly but are still happy to review sooner than five years.

“It also doesn’t account for what might change, and external factors will clearly make a big difference to the outlook for rates over time.

“Rather than trying to predict what might happen, borrowers would have a better idea of ​​what will work best for them.

“Those who will own them for longer may be happy to lock in the rate for five years or more and should not turn down the option.

“Those hoping to see rates fall can clearly take a more short-term view, but they should consider their position if things change and whether they can cope with higher rates and payments.”