I have a standard variable rate mortgage that jumps to 5.99 percent from next month.
My loan is around £125,000 and my age is from 12 to 25.
What is the best path for me to mitigate the extra cost? Extend the term of the loan or choose a fixed rate? SD, Watford, Herts
Balancing: Since December, we’ve had six increases in the BoE base rate and it will continue to rise as long as inflation continues to be high.
Jeff Prestridge replies: The first step is to urgently review your mortgage deal. Standard variable rate loans are rarely a good option – especially when interest rates are rising as quickly as they are now.
Since December we’ve had six increases in the BoE base rate and it will continue to rise as long as inflation continues to be high.
A variable rate home loan does not provide any financial protection against higher interest rates. The night surely follows the day any increase in the prime rate is fully reflected in a variable rate loan.
Banks and building societies may be slow to raise savings rates, but when it comes to mortgages, they happily do so.
By remortgaging a fixed rate loan, you will reduce your payments. More importantly, you’ll be closing in on one of your biggest financial expenses, giving you some budget security to offset the impending sharp rise in energy bills.
I asked David Hollingworth, mortgage expert at brokerage L&C Mortgages, to do some number analysis on your situation. He says you’ll likely pay around £1,155 a month once the new mortgage rate of 5.99 per cent kicks in next month.
But if you lock in a five-year fixed-rate loan of 3.09 per cent with First Direct, for example, you’ll reduce your payments to just under £974 – a saving of over £181 a month, or £2,175 a year. .
Of course, the savings will be even greater if your current loan rate rises to 6.49 percent in the coming months, thanks to another 0.5 percentage point increase in the base rate. Your monthly savings from installation would then be around £214.
This illustration assumes you have at least 35 percent equity in your home — very likely that you’ve taken about halfway through your loan and are set up on a repayment basis where the payments pay a mixture of interest and principal.
If you have fewer shares, fixed-price deals are more expensive, though you’re still in a better position than now.
As is the norm across the industry, you will have to pay a fee (£490) to re-mortgage, but this cost will soon be wiped out by the savings made on installation.
There are other fixed rate deals as well as five years. Two-year repairs are common, as are ten-year ones. For example, Virgin Money is offering a ten-year fix at 3.3 per cent – not much more expensive than First Direct’s five-year deal.
Although ten years of a payment guarantee is tempting, Hollingworth says you need to make sure it matches your future financial plans. “Many fixed-rate loans carry an early repayment fee, so you need to be confident you’ll stay the course,” he says.
For example, this fee on a ten-year Virgin Money deal starts at eight percent of the outstanding balance – and then decreases the longer you hold the deal.
When you take this major first step, you can also extend the term of the loan as you suggest.
This will lower your monthly payments, although you’ll end up paying more interest in the long run. The table, to the left, gives you an idea of how extending your £125,000 loan will affect your monthly payments and the total interest you end up paying.
Assuming a default payment rate of 3.5 per cent over the remaining 13 years of your mortgage term, your loan would cost just over £998 a month – and you’d end up paying a total interest of £30,766.
Alternatively, extending the remainder to 20 years would result in a lower monthly payment (just under £725), but you’d pay close to £49,000 in interest – £18,000 over 13 years.
Although banking association UK Finance says 30-year mortgage terms are the norm, Hollingworth warns homeowners to tread carefully.
He explains: ‘When extending the term of a loan, the lender will need to ensure that the mortgage is affordable now and in the future. If the term extends beyond someone’s expected retirement age, they may need some assurance that the borrower’s retirement income will be adequate.
Therefore, getting a costly standard variable rate loan should be your priority. Extending the loan is of secondary importance.
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