Tempted by a 10 year mortgage?
The 10 year mortgage, where your rates are fixed for a whole decade, is still a rare beast but has started to hit the headlines. On the face of it they may appeal to some people – but is such a mortgage really worth considering, and who might want one? Matt Harris of Dalbeath Financial Planning doubts the hype.
Taking out a mortgage is typically stressful – and you may find the greatest stress can be the level of uncertainty involved. Will interest rates rise, how soon might they rise, and by how much? Will I be able to afford the higher repayments? These are questions that no-one can answer with 100 per cent certainty. So the prospect of a mortgage with a rate fixed for 10 years may initially seem very attractive. The obvious benefits are as follows:
- Complete certainty about how much your mortgage payments will be for the next 10 years.
- Interest rates are at a historic low, so you may be locking in a great rate at the perfect time.
- Remortgaging can involve fees, which you will avoid for 10 years.
However, there are downsides to consider too:
- You will not be able to repay the mortgage in full within the first 10 years, without incurring potentially large penalty charges. You may still be able to move house, but only if you take the mortgage with you, which is only possible if the lender approves it.
- Your monthly payments will be higher than under a shorter term fixed rate.
- If mortgage rates continue to fall then you will miss out on the chance to lock in a lower rate in future.
Weighing up your options
Here’s an example of the kind of choice you might face. Esme is thinking about buying a £300,000 house with a £250,000 mortgage. If she considers the best deals on the market at the moment, she would have the following options open to her:
1) A 2 year fixed rate mortgage with Accord, at 2.54%, with upfront fees (after cashback) of £225 and an initial monthly payment of £1,126.
2) A 5 year fixed rate mortgage with Leeds Building Society, at 3.59%, with upfront fees of £35 and an initial monthly payment of £1,263.
3) A 10 year fixed rate mortgage with TSB, at 4.29%, with upfront fees of £450 and an initial monthly payment of £1,359.
Which of these should she go for?
Over the first two years of her mortgage, Esme would pay:
£27,249 under the 2 year deal
£30,347 under the 5 year deal
£33,066 under the 10 year deal
Let’s keep it simple and compare just the 2 and 10 year options.
If Esme opted for the 10 year fixed rate mortgage, she would pay £5,817 (or 21%) more in extra interest payments during the first 2 years alone than if she had chosen the 2 year fixed rate mortgage.
Over the whole 10 year term the extra cost gets even greater. If Esme manages to borrow at 2.54% for the whole 10 year period (which she may be able to do by taking out five short fixed rate deals in succession) then she would pay around £136,245 over the whole period. By contrast, if she chooses the 10 year fixed rate, then she would pay around £165,000 over the 10 years.
That adds up to a difference of more than £29,000. Is that a price worth paying merely for increased certainty over what her mortgage will cost each month? Many would say, no it isn’t.
Although remortgaging five times during that period could incur fees, these should be £400 at most each time, and with the right advice remortgaging could even be free of charge. That doesn’t come close to closing that £29,000 gap.
The only thing that would make the 10 year deal the best option, in this scenario, is if interest rates were to rise significantly over the 10 year period. How significantly? Well, 2 year fixed rates would have to increase to 4.5% or more for Esme to be better off choosing the 10 year option. This chart from the Bank of England shows when we last saw rates at that level, which was during the housing boom of 2005-2007:
On reflection, Esme decides that the 10 year deal doesn’t represent good value for her. So who might decide to go for it?
The only obvious circumstances in which you might consider a 10-year fixed rate are: if you are in (or about to buy) a home that you intend to stay in for at least 10 years, and you also believe that interest rates will rise sharply in future, and – furthermore – you are worried that this would cause you difficulties in making your monthly mortgage payments, then you might consider taking out a 10 year fixed rate. For everyone else, a series of shorter term fixed rate deals looks to be the better option by far. Remember that remortgaging is fast and easy, and with the right advice can also be fee-free.
You can also be certain that with a 2 year fixed rate mortgage your monthly payments will be significantly lower, in the short term at least. This represents more money in your bank account, giving you greater spending (and saving) power now. For most people, this will outweigh the theoretical, uncertain savings that may come from taking a long term fixed rate deal.
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Matt Harris, director of Dalbeath Financial Planning, is a qualified independent financial and mortgage adviser. Matt advises clients on all areas of their finances, including mortgages and life insurance, but particularly specialises in pension and wealth management.