One of the most common questions that borrowers ask when taking out any kind of mortgage or secured loan is: “Should I take a fixed or a variable interest rate?”
While fixed rates have traditionally been the favourite type of product over the last couple of decades, many people have benefited from low variable rates over the last few years. So, if you’re considering a home equity loan, here are the advantages and disadvantages of both types of deal.
Advantages and Disadvantages of Fixed Rates
Fixed rates guarantee your home equity loan repayments, meaning you will know exactly what you are going to pay for a specified period. Consequently, it is this certainty that is one of the main attractions of a fixed-rate deal.
Whatever happens to the Bank of England Base rate and whatever happens in the wider economy, a fixed rate means that you will always have the security of knowing exactly what you’ll pay. Even if interest rates rise significantly, your rate will remain fixed. You therefore have the certainty of being able to budget and work your household finances around these payments.
If you took out a £50,000 home equity loan at a fixed interest rate of 5%, you would pay £208.33 per month on an ‘interest only’ basis. If interest rates went up to 8%, you would continue to pay £208.33 per month, rather than someone on a variable rate that would pay £333.33 for the same ‘interest only’ loan at 8 per cent.
The main disadvantage of a fixed rate is that they are generally more expensive than variable rate loans. You tend to pay a premium for the security of a guaranteed rate and so your initial repayments may be more expensive than the comparable variable deal. As mortgage expert Simon Tyler told the BBC: “Ultimately a fixed rate mortgage is an insurance policy, and you may well be paying more for the product today.”
In addition, if you’re on a fixed rate and interest rates fall, you will continue to pay the same amount. You won’t benefit from any reduction in interest rates.
Advantages and Disadvantages of Variable Rates
Variable-rate home equity loans are generally linked to either a lender’s ‘standard variable rate’ or to the Bank of England Base rate. This means that when interest rates go up and down, your interest rate (and consequently your loan repayments) goes up and down accordingly.
In an economic climate where interest rates are falling, or are likely to remain low then a variable-rate home equity loan can be cheaper than a fixed-rate deal. On a variable rate, you will generally benefit each time interest rates are cut and your repayments will reduce accordingly.
In addition, variable rates are often cheaper than the fixed rate equivalent, meaning your initial repayment will be lower.
However, the danger of taking a variable-rate home equity loan is that your repayments could rise significantly if underlying interest rates were to rise. A 1% rise in interest rates adds £8.33 to every £10,000 of an ‘interest only’ home equity loan so if you have a large loan and interest rates rise significantly, your repayments could increase by a substantial amount.
To access the money tied in your home equity and get a great loan rate, book an appointment with the Mortgage Genie.