Choosing Fixed or Variable Rate on Mortgage

I apologise in advance if i should not be asking a question like this on here.

Here is the background. Tried for a mortgage for 18 months to no avail even though we had good savings, looking for a small mortgage and no loans. After losing heart with the mortgage process we went ahead and started building out of savings. The house is built with 38k left to finish.

A mortgage has been approved of 55k.

We have been told to think if we want it fixed or variable.
This is what we are unsure of. We would want to pay off extra but most likely not in the first 2 years.

2 year fixed - Rate of 4.61% - Repayments Monthly EUR351
Variable <=50% LTV - Rate 3.95% - Repayments Monthly EUR332

I am thinking fixed as i can't see the repayments going much lower than 332 and the fixed we would at least know what the repayments are for the next two years and go variable after the two years to plough into the mortgage to get rid of it in the ten years.

Any advice on what you would do if you were in our position. I know no one can tell what way rates will go but if you were in our position which would you decide for yourself and why.

Thanking you in advance.

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Brendan
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Personally, I would go variable and start to overpay straight away..

I would go variable. ECB rates are likely to say where they are (or even go lower) until at least Spring 2015 (according to the head of the ECB last week). Most of your two year fixed will be over by then.

If you go variable and then overpay by what you would have been paying on the fixed rate, you will be eating into the mortgage already!

Fixed rates for mortgages are ALWAYS set in favour of the bank...

Thank you.

This morning what i am thinking is this.

I say in my head that i don't think interest rates could go over 8% in two years. I do not know of course, i am thinking surely they wouldn't.

The monthly repayments if interest rates went to 8% would be EUR460
I take the variable but in my mind 'pretend' the rates are 8% and pay the EUR460 from the beginning.

If the rates go up we won't feel it as we won't notice as would be paying that from day one by 'pretending that's what the current rate/repayment is'.

If they stay the same it would would save near 10k on the mortgage and paid off 7 years earlier?

So basically take the variable, set it up to pay EUR460 per month from the beginning. Then throw extra off it seperate to the monthly direct debit.

Stupid thinking to go with?

Also the LTV rate? How does that work. Does it eventually change to the standard variable rate or does it remain as LTV for the duration? Does it continue to stay lower than the SVR once you choose it from the beginning?

Demented1 - that seems like a good way to set the minimum monthly payment. But personally I wouldn't let that limit how much I overpay on the mortgage.

tallpaul - with variable interest rates being set at the banks' discretion, surely they're not much more in favour of the person who took out the loan, compared to fix rates?

whytis, fixed rate are basically a premium product. You pay for the bank to take on all the risk of rate changes for an agreed period of time. Generally banks will try to price in rate changes into a fixed rate so usually they work out more expensive over time.

whytis said:

Demented1 - that seems like a good way to set the minimum monthly payment. But personally I wouldn't let that limit how much I overpay on the mortgage.

tallpaul - with variable interest rates being set at the banks' discretion, surely they're not much more in favour of the person who took out the loan, compared to fix rates?

Click to expand...

so-crates said:

whytis, fixed rate are basically a premium product. You pay for the bank to take on all the risk of rate changes for an agreed period of time. Generally banks will try to price in rate changes into a fixed rate so usually they work out more expensive over time.

Click to expand...

Precisely. With a fixed rate, the bank has calculated the odds on the direction of interest rates. In addition, they always include a margin that nervous buyers are willing to suck up for relative stability.

I would argue that fixed rates are NEVER good value for periods of less than three years. Without having immediate figures to hand, I doubt that SVR rates have gone much above the equivalent prevailing fixed rate available at the time of purchase within the following three years, or certainly not long enough to have saved money over the period.

In essence, people who opt for fixed rates pay a significant premium for 'peace of mind' and a fixed monthly outgoing.

Thanks to so-crates and tallpal.

So how come SVR is not a premium product? It's not directly affected by calculated odds, but it will be as high as they can manage to set it, against market demand. Is it that supply and demand of the mortgage market means that SVR products don't get too much higher above the ECB rate?

Point taken on the extra margin for charging nervous buyers.

An SVR means you take the risk, so to encourage you to do that it will generally be lower than a fixed, they will still need to build in a margin to make money on it but if their costs go up, they can pass them on directly to you. So yes, it is the market that determines whereabouts the rates sit. The better the customer in terms of their ability to repay, their risk profile, the better the rate they will offer them because those customers will be able to pick and choose so the rate a customer will be quoted by three different institutions is unlikely to vary wildly. This was where the "sub-prime" market came in (don't really know whether sub-prime mortgages are particularly accessible at the moment!) this is the market of those who banks deem risky, the rates they will be quoted will be higher

So crates are you saying they want me to take the SVR, i thought they wanted customers to take the fixed?

I am getting confused now.

Sorry for confusing you Demented1. When I say "premium" I don't mean better for or more attractive to the bank, I mean you pay extra for the privilege. They would like to loan you money at a price they make a profit on. An SVR is kind of like the baseline to compare everything else to. They will make money on it. If the rates go up, the risk of rate rises are all on you. If you say to them I want you to fix my rate, they will quote you a premium rate because it is less flexible for them, so this will be higher than the current SVR. Realistically they would prefer you take the risk.

Thank you.

Sorry i am so clueless on all this. The more i read the more confused i get. Variable seems to be the way to go according to all i have read but with such low repayments and the small difference a decrease of rates would make my partner is leaning towards fixing them and saving the remainder to put off it after two years of fixed.

The LTV of 3.95 is for one year and onto the SVR then.

I think i will just let partner decide and he has less of an idea than me as he has not read or searched any topics about them.

To me the bottom line is the plan all along before approval was if approved we wanted to get rid of the mortgage in ten years approx. I don't know if fixing it for 2 years would make a difference to that. Yes could not pay off in the first two years but would then have the lump sum to pay off it once the fixed rate was up and then decide to go fixed or variable again then

Someone should really do a keypost on this.

The ECB rate has little to do with the way banks set their rates anymore outside of the trackers. The SVR and fixed rates are based on the banks blended borrowing rates, basically the rate that they can borrow money at. This disconnected wildly from the ECB rate back in 2008. LTRO did have an impact but didn't change things much.

It gets stranger when you look at fixed rates vs variable rates. Right now a 2 year fixed is *lower* than the SVR in most cases >50% LTV. In a normal situation this would mean the banks think the SVR is going to drop. All the economy signals point the other way.
Even if you look at the banks borrowing rates, they too point that rates will go up. Banks have seen around 20-40bps added to their rates recently, but it has been a slow increase since the low point in the middle of the year. And yet the rates are still lower than the SVR.

At the end of the day, the reality is a mortgage covers a long period of time, and almost everyone with a mortgage is going to see the rates change at some point during that period. If you can't afford an increase, then choose a fixed rate, although perhaps you are borrowing too much? Remember too that if rates did go to 8% from the current ~4.5%, tracker rates are likely to have risen, and that'll bring a whole host of other problems.

Demented1 said:

2 year fixed - Rate of 4.61% - Repayments Monthly EUR351
Variable <=50% LTV - Rate 3.95% - Repayments Monthly EUR332

Click to expand...

Demented1 said:

Variable seems to be the way to go according to all i have read but with such low repayments and the small difference a decrease of rates would make my partner is leaning towards fixing them and saving the remainder to put off it after two years of fixed.

The LTV of 3.95 is for one year and onto the SVR then.

Click to expand...

Okay, maybe the simplest way to look at this is by doing the maths (or letting Karl Jeacle's calculator do it!)

Am I reading this correctly, the options are:
1) 55,000 @ 4.61% for 2 years
2) 55,000 @ 3.95% for 1 year - then onto a higher rate?

For the sake of seeing past the end of year 1, I am going to use an SVR of 4.61%

Right - the cost (i.e. the interest paid) on the first option works out at
Year 1: €2,499.56 (Balance outstanding: €53,284.78)
Year 2: €2,418.80 (Balance outstanding: €51,488.80)

Total cost for two years: €4918.36
Balance at end of year 2: €51,488.80

For option two (a little harder as we don't have a definite rate for your second year! ) in order to give as fair a comparison as possible I am going to take the Fixed Rate interest rate as your rate for your second year (their current SVR would probably be lower though and you may experience rate variation).
Year 1: €2139.38 (Balance outstanding: €53,157.27)
Year 2: €2413.01 (Balance outstanding: €51,365.59)

Total cost for two years: €4552.39
Balance at end of year 2: €51,365.59

Difference in cost: €365.97

The certainty of a fixed rate is costing you about 50c per day

Now...

Lets throw in an overpayment, say you can either save €50 per month and pay a lump sum off at the end of year 2 where you have fixed or pay off €50 per month where you are on the variable. Let's do it for two cases, from the very start, or from the start of year 2.

I am going to be bad and not calculate the interest you would earn on your monthly deposit of €50 into a savings account, it will slightly help but it won't make a massive difference.

Overpayment on variable from month 1:
Year 1: €2,128.39 (Balance outstanding: €52,546.29)
Year 2: €2,372.43 (Balance outstanding: €50,162.36)

Total cost for two years: €4501.82
Balance at the end of year 2: €50,162.36

Overpayment on variable from month 13:
Year 1: €2139.38 (Balance outstanding: €53,157.27)
Year 2: €2400.17 (Balance outstanding: €50,752.75)

Total cost for two years: €4539.55
Balance at the end of year 2: €50,752.75

Now for the fixed...
A one off payment of €1200 on fixed in month 25 brings your balance down to:
€51,365.59 - €1,200 = €50165.59

A one off payment of €600 on fixed in month 25 brings your balance down to:
€51,365.59 - €600 = €50765.59

The balance reduction is slightly greater if you apply it incrementally rather than as a lump sum.

Do the above calculations only confuse you more or do they give you an idea of what is going on?

Demented1 said:

To me the bottom line is the plan all along before approval was if approved we wanted to get rid of the mortgage in ten years approx. I don't know if fixing it for 2 years would make a difference to that. Yes could not pay off in the first two years but would then have the lump sum to pay off it once the fixed rate was up and then decide to go fixed or variable again then

Click to expand...

Getting rid of the mortgage in ten years... (the calculator has prepayment options )
if you go variable and you start overpaying in month 13 (and not accounting for interest rate changes!), you would need to overpay by €250pm

if you go variable and you start overpaying in month 1 (and not accounting for interest rate changes!), you would need to overpay by €240pm

if you fix for the first two years and you start overpaying in month 25 (and not accounting for interest rate changes!), you would need to overpay by €290pm

I am hoping that all the above doesn't confuse you even more. I think perhaps start plugging stuff into the calculator and see for yourself. Playing with the numbers is a good way to get a feel for how this plays out.

Thank you very much. I had been messing around with calculators working out to pay it off earlier.


Thank you for the figures. It really is shocking to see how LITTLE comes off the actual balance for the amount of money paid. I think seeing it like that it makes me want to overpay from the beginning and be done with it and try and bring down the amount of interest we pay in total for the mortgage. We don't have other loans so we could easily pay 1000 per month without feeling it as it would be replacing the rent. I guess the smaller payment per month makes you think of some extra things we could do after years of watching every cent. I have three children under the age of 3 so really i think we should take variable and keep paying off the 1000 we are used to to get rid of the mortgage before the kids get expensive.

Thanks for that. It has made it a lot clearer what to do.

In the first few years you are paying more in interest than you are paying off the capital.
As a consequence early overpayments are more significant in reducing the length of time and the amount of interest repaid

And yes - it totally sucks to look at a mortgage statement and realise by how little it has reduced in the first year!

Good luck, and just don't overstretch yourselves. Overpaying by €670 might be hard to manage even if you are used to a higher rent.