Sometimes getting a fixed rate or any type of mortgage can feel like stepping into a casino. There are a lot of sounds and flashing lights, and let’s be honest, we don’t really have a clue what we’re doing. You might find yourself at the roulette table turning everything red and the fun will end very quickly. But at least when you walk into a casino you understand that you are taking a risk. You might not really have a clue about the optimal blackjack betting strategies or the difference between Texas Hold ‘Em and Omaha, but at least you understand that you are making your bets and winning or lose. Even with the hope that the house generally wins.
But when it comes to buying a home, the biggest purchase you will typically make in your life, do you really understand what the risks are? The Motley Fool walked you through the main differences between typical mortgages, and you might get a vague idea that the Bank of England interest rate they bleat in the news every two months might have some correlation with the mortgage rate you are paying. You might even get the impression that the interest rate environment is quite low right now. But what are the disadvantages of committing to a long-term fixed interest rate?
Yes, fixed rate mortgages tend to be slightly more expensive than their variable counterparts, and you lose out if the going interest rate drops. But the real blow to a fixed rate mortgage can be the prepayment charge (ERC). Sounds very transactional, doesn’t it? But it could cost you thousands of pounds or even tens of thousands if you’re not careful.
Many people consider purchasing life insurance or critical illness coverage to protect their financial interests. In fact, it is a multi-million pound industry in its own right. At the heart of it all is the acceptance that sometimes things in life don’t turn out the way you would expect. Why, then, are so many buyers of a fixed rate mortgage product ignoring the ERC?
Worse yet, not all exit plans are created equal. Do you know if you can “carry” your fixed mortgage product if you move? A port is not just a place a ship goes, it is a mechanism for transferring your mortgage to a new home that you buy. Not all mortgages allow you this, so you might consider a 5 or 10 year solution knowing full well that you will likely want to sell your home during that time, but without understanding the potential costs of doing so. .
Even if your mortgage theoretically allows you to âcarryâ the proceeds, you may find that your personal circumstances have changed. For example, your partner had a job, but his life changed, as it is, and decided to take care of the children because the cost of child care is so prohibitive. It might not make any financial difference to you, or oddly, you might even be in a better financial position, but your mortgage provider might not like your household having only one income now. The computer can – and regularly does – say no.
And don’t even get me started on the dreaded housing chain and what if you decide to sell before you buy. Some fixed rate mortgages offer some leeway, but not all, and often very limited. Even if you have the luxury of a port and can make it work, you might feel pressured into making a decision that isn’t right for you due to the potential cost of ERC.
The tendency for financial products is to make them all look equal, so our focus is on the overall rate, but with fixed mortgages the devil is very often in the details and not all solutions are created equal. The next time you consider a long-term fixed mortgage product, make sure you understand the product you are purchasing. Otherwise, you might end up on the roulette table with a nasty surprise when the spinning stops.
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