Do I extend the term of my mortgage… or fix the rate?

I have a standard variable rate mortgage with an interest rate that jumps to 5.99 percent starting next month.

My loan is around £125,000 and I am 12 years old on a 25 year term.

What is my best course of action to alleviate the additional cost? Extend the term of the loan or opt for a fixed rate? SD, Watford, Hertz

Balance: Since December, we have had six increases in the Bank of England base rate and it will continue to increase as long as high inflation persists.

Jeff Prestridge replies: The first step is to urgently review your mortgage contract. Standard variable rate loans are rarely a good option, especially when interest rates are rising as fast as they are now.

Since December, we have had six increases in the Bank of England base rate and it will continue to increase as long as high inflation persists.

An adjustable rate home loan does not provide financial protection against higher interest rates. As sure as night follows day, any increase in the base 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’re trigger-happy.

By remortgaging with a fixed-rate loan, you’ll lower your payments. More importantly, it will lock in one of your biggest financial expenses, giving you some budgetary security to offset the impending spike in energy bills.

I asked David Hollingworth, a mortgage expert at broker L&C Mortgages, to do some number crunching on your situation. He says he will probably pay around £1,155 a month once the new 5.99 per cent mortgage rate takes effect next month.

But if you take out a five-year fixed-rate loan at 3.09 per cent with First Direct, for example, it would bring your payment down to just under £974, a savings of more than £181 per month or £2,175 per year.

Of course, the savings would be even greater if the rate on your current loan increased to 6.49 percent in the coming months, thanks to another 0.5 percentage point increase in the base rate. Your monthly savings for the repair would be around £214.

This illustration assumes you have at least 35 percent equity in your home, which is highly likely given that you’re almost halfway through your loan and it’s set up on a repayment basis where payments pay a combination of interest and capital.

If you have less capital, the fixed-rate offerings are more expensive, although you should still be better off than you are now.

As is typical across the industry, you would have to pay a fee (£490) to remortgage, but that cost would soon be wiped out by the savings made from the repair.

There are other fixed rate offers besides five years. Two-year solutions are common, as are ones that span ten years. For example, Virgin Money offers a ten-year fix at 3.3 per cent, not much more expensive than First Direct’s five-year offer.

While ten years of payment certainty is attractive, Hollingworth says you need to make sure it fits in with your future financial plans. He says, “Many fixed-rate loans come with early repayment fees, so he has to be sure he’ll stay the course.”

For example, such fees on the ten-year Virgin Money agreement start at eight percent of the outstanding balance, and then decrease the longer the agreement is held.

By taking this first key step, you could also extend the term of your loan as you suggest.

This would lower your monthly payments, although you would ultimately pay more in interest in the long run. The table to the left gives you an idea of ​​how extending his £125,000 loan would impact both the monthly payments and the total interest he will end up paying.

Assuming a hypothetical payment rate of 3.5 per cent over the remaining 13 years of your mortgage term, your loan would cost just over £998 per month, and you would end up paying £30,766 in total interest.

Alternatively, extending the remaining term to 20 years would result in a lower monthly payment (just under £725), but you pay almost £49,000 in interest, £18,000 more than over 13 years.

Although the UK Finance banking association says 30-year mortgage terms are the norm, Hollingworth cautions homeowners to be careful.

He explains: ‘When extending the term of a loan, a lender will need to ensure that the mortgage is affordable now and in the future. If the term extends beyond someone’s early retirement age, you may need some reassurance that the borrower’s retirement income will be sufficient.’

So getting out of that expensive standard variable rate loan should be your priority. Extending the loan is of secondary importance.

best mortgages

Some links in this article may be affiliate links. If you click on them, we may earn a small commission. That helps us fund This Is Money and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.