Is a five-year fixed mortgage now the best option as interest rates set to stay higher for longer?

Those buying a home or remortgaging now have a tough call to make when deciding how long to fix their mortgage rate for.

Last year, most borrowers opted to fix for two years. They believed that interest rates would begin falling during that time, and a shorter fix would allow them to switch to a cheaper rate more quickly. 

However, confidence that rates will fall drastically any time soon appears to be dissipating, meaning that increasing numbers are now choosing to lock in their rate for five years, according to mortgage broker L&C. 

Big call: Mortgage borowers are finding it hard to decide whether to opt for two-year fixes or five-year fixes. We asked two experts for their view

What is happening to mortgage rates? 

Mortgage rates have gradually risen since the start of February, which is the opposite to what most people were expecting at the start of 2024. 

In January, financial markets were forecasting that the Bank of England would begin cutting the base rate, which impacts mortgage pricing, from March.

However, disappointing inflation readings, both here and in the US, have caused the Bank of England to hold rates for longer than expected.

Now, the general consensus is that the first base rate cut will come in August – six months later than previously envisaged.

As a result, rather than falling, the cheapest fixed mortgage rates have actually edged up by roughly 0.5 percentage points since January with lenders pricing in a ‘higher for longer’ scenario for interest rates.

The average five-year fixed rate stands some 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 these deals are aimed at buyers rather than homeowners remortgaging.

Someone with a £200,000 mortgage being repaid over a 25 year term would save themselves £57 a month by choosing the cheapest five-year option.

What are mortgage borrowers doing? 

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 predicted to fall over time continues to see a division in the product take up between those opting to lock in for a couple of years over a longer time frame,’ he says. 

‘We have seen a slight shift back from two-year fix to a more even split in the proportion opting to fix for two or five years.

‘As the market has stabilised the attraction of the lower five-year rates may be attracting more interest, especially as no one knows how low rates may drop to in reality.

He added: ‘There’s still an expectation for base rate to fall this year but that has continued to shift both in terms of timing and how steep the fall might be.

‘Nonetheless it can make borrowers indecisive about whether they may be locking in at a time when rates are higher.’ 

50:50: David Hollingworth, associate director at L&C Mortgages says the firm is now seeing a more even split in the proportion opting to fix for two and five years

Should you fix your mortgage for five years?

The obvious incentive to fix for five years is that it is currently almost always cheaper to do so.

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

Nobody wants to lock into a 5 per cent rate five-year fix in 2024 only to find they could have remortgaged onto a 3 per cent rate in 2026 if they had opted for a two-year fix instead.

The market-implied path for base rate in May’s Bank of England’s Monetary Policy Report is that it will fall from 5.25 per cent to around 3.75 per cent by the end of 2026.

It’s worth pointing out that this forecast has risen by 0.7 percentage points on average, compared with the equivalent period in February’s report.

Lowest mortgage rates vs base rate: Between 2008 and 2022 the Bank of England base rate has always been higher than the lowest fixed rate mortgage

What are mortgage rate predictions based on? 

Lenders’ fixed rate mortgage pricing is governed in large part by Sonia swap rates.

Mortgage lenders enter into interest rate ‘swap’ agreements to shield themselves against the interest rate risk involved with lending fixed rate mortgages.

The rates they pay to do this, known as swap rates, show what lenders think the future holds concerning fixed rates.

As of 11 June, five-year swaps were at 4.09 per cent and two-year swaps were at 4.62 per cent – both trending below the current base rate.

‘It’s important to remember that fixed mortgage rates look to predict the path of interest rates,’ says L&C’s David Hollingworth.

‘As a result the fixed rates currently on offer are pricing in the current market expectation for a lower base rate.

‘That is why fixed rates are lower than the variable rate options, and also why fixed rates can move up and down despite the fact that base rate is yet to shift at all.’

Hold: The Bank of England has opted to hold the base rate at 5.25% since August

When could mortgage rates fall? 

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

He adds: ‘Many economists feel that base rate will continue to drop back and the implied path looks to suggest that the base rate could drop to 3.75 per cent in 2026.

‘That marks an upward shift in recent months though, and none of this can be guaranteed.

‘Even then, fixed rates on offer at that time will very much depend on where rates are expected to head from there.

Peter Stimson, head of the product development team at MPowered Mortgages says that he thinks mortgage rates have now peaked

‘If there’s potential hikes on the way then fixed rate pricing may not be a long way off where we are now. If there was a further drift downwards anticipated then fixed rates may price in lower rates.’

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

‘We believe mortgage rates are now at their peak,’ says Stimson.

‘This, however, shouldn’t mean that consumers should expect mortgage rates to fall immediately if the Bank of England cuts interest rates. 

‘Much of the assumed cuts have already been accounted for in the pricing of forward interest rates.

‘So, how much rates fall by, is really going to depend very much on how much inflation falls by in the months ahead and the extent and timing of any Bank of England rate cuts.

‘Whilst we hope mortgage rates have now finally reached their peak, if this year has taught everybody one thing, it’s that there are no guarantees when it comes to predicting what will happen next with mortgage rates.’

One thing that most commentators and experts agree on, is that mortgage rates won’t be returning to the lows enjoyed before 2022, when borrowers with the most equity were able to secure rates of less than 1 per cent.

‘We certainly don’t see any return to the decade-long low interest rate period from 2010 to 2021,’ says Stimson.

‘Longer term, we feel the Bank of England interest rates are likely to settle broadly around 4 per cent, but there could be a range either side of this depending on what happens to the economy at large.’

If Stimson, among others, is correct, and interest rates do settle around 4 per cent or even a bit lower, then it’s unlikely we will see much change when it comes to fixed mortgage rates either.

Prior to the quick-fire base rate rises between December 2021 and August 2023, the lowest mortgage rates trended above base rate. That was the case between 2008 and 2022.

This means that even if the base rate settles at around 4 per cent, we should expect mortgage rates to be higher than that, unless there is reason to believe rates will fall further.

What do mortgage borrowers need to consider? 

Ultimately, choosing what length to fix for depends on what someone thinks will happen to interest rates during that time.

It will also depend on their personal circumstances. If someone thinks they will need to move in less than five years’ time, a five-year fix is not ideal because there will normally be fees to pay to exit the deal early. 

Those opting for a two-year fix are essentially hedging their bets on interest rates falling over the next couple of years.

They will be banking on the expectation that once inflation fully subsides, interest rates will come down.

They are prepared to stomach the higher rates for two years in the hope that the rate they then move to 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 run and get certainty over what their payments will be for a lot longer.

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

Although these are currently more expensive than fixed rate deals, a tracker mortgage without an early repayment charge could put borrowers in a position to take advantage of base rate cuts.

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

Hollingworth adds: ‘We can see an increase in three year fixed rates which may strike a balance for those that feel two years could come round too quickly but are still happy to review sooner than over a five year timeline.

‘There’s also no accounting for what may change and external factors will clearly make a big difference to the rate outlook over time.

‘Rather than trying to predict what may happen, borrowers would be better on what will work best for them.

‘Those that will be in their property for a longer period may be happy to lock the rate in for five years or longer and shouldn’t dismiss the option.

‘Those that do hope to see rates drop can clearly take a shorter term view, but should consider their position if things change and whether they have ability to cope with higher rates and payments.’