Take a fixed rate mortgage in a volatile economy

Reuters/Jumana El Heloueh

To fix or not to fix a mortgage rate is a question that is frequently asked. Mortgages can be set up with a number of interest rate options and you need to understand them in order to choose what is best for you in your particular situation.

Historically, the only option was for a variable rate where the rate payable can move up and down broadly depending on the main bank base rate of the country in which you are borrowing. This is all well and good when interest rates are low and payments are easily manageable, but doesn’t allow for consistent budgeting.

Another option is a tracker mortgage. These are slightly different as the rate you pay is specifically linked to the bank base rate. If the rate increases, your payments will increase, if the rate falls, your payments will fall.

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Unlike a standard variable rate, where lenders decide on the margin above the basic rate and when it moves, if at all, a tracker mortgage gives you the certainty of moving with market rates.

Fixed rate mortgages first appeared in the US in the mid-1950s, with 30-year terms being common. More than 90 percent of American borrowers have some form of fixed rate. The UK mortgage market is very different and the first fixed rates were not offered in the UK until 1989.

This was a time when interest rates were very high, with many people paying rates of 15 percent by the end of 1990. Their popularity has remained, with as many as 75 percent of UK borrowers choosing fixed rates, albeit with far shorter terms on offer than in the US. 

The UAE mortgage market is closer to the UK in terms of the options available, and with fewer fixed rate options, but this may be partly due to rates being relatively low over the past 15 or so years that property ownership has taken off.

With the increases in central bank base rates across most developed countries, and rising inflation, there has been a resurgence in demand in fixed rates as borrowers start to worry about increases, not just in their mortgage repayments but also in respect of the cost of living generally.

The main advantage of a fixed rate loan is that the borrower is protected from sudden and potentially significant increases in monthly mortgage payments if interest rates rise.

There is a great deal of comfort in knowing that your main monthly outgoing is not going to change and so it allows you to budget and manage your money better. It takes away the worry of rising rates and gives some financial security.

It is no secret that money worries are one of the biggest causes of stress and if you can take steps to reduce that worry it is usually a smart move.

In the UAE, and also in the UK, most fixed rates are for relatively short periods of time – usually two, three or five years – but that means that you fix at current rates, rather than being locked into a rate that could be much higher than the average in a few years’ time.

The potential downside of a fixed rate is that you could end up paying more than someone on a variable rate, but that is a trade-off for the security of fixed repayments.

You also need to be aware that there are likely to be penalties for wanting to repay a fixed rate mortgage before the end of the set period but there is usually an option to make an annual overpayment of up to 10 percent of the total borrowed without being penalised. 

With the increases in interest rates in the past year, and with the likelihood of more pain to come for borrowers, if you have a variable rate mortgage now may be the time to switch to a fixed rate.

Even if you don’t end up saving much money, if at all, you’ll have the comfort of knowing that you can afford your repayments and won’t need to worry about further increases for a few years.

It is good to have the security of knowing that at least your mortgage payments won’t change even when in a volatile economic environment.

Having worked in financial services for 30 years, my advice is invariably to take the fixed rate mortgage option, knowing that what you are paying for is also financial peace of mind.

Keren Bobker is a Dubai-based independent financial adviser and senior partner at Holborn Assets