Fix your mortgage for three years below 3%

Norwich and Peterborough has launched its cheapest ever three-year fixed rate mortgage - but is 36 months an appropriate length to lock in for? Robert Powell takes a look.

In the mortgage market, a lot can happen in three years. Fixed rate home loans are designed to protect against these peaks and troughs: lock in your monthly payments, sit back, and watch the market wax and wane to its heart’s content.

But how long is long enough when it comes to fixing your rate? Norwich and Peterborough Building Society has provided one very frugal answer to this question in the form of a competitively priced three-year mortgage – a home loan the lender claims is its cheapest 36-month deal ever.

Fix below 3%

N&P’s new three-year fix is priced at 2.99% with a £795 fee. The minimum deposit required is 25% (75% loan-to-value).

The lender also has a lower fee option: fixed for three years again, with a £295 fee. However the rate is slightly higher at 3.09%. Also in the new range is a two-year fixed rate at 2.94% with a £295 fee – this is again available to borrowers with a 25% deposit.

Now, these new N&P mortgages are undoubtedly competitive, but there are still a few other lower priced deals out there.

Other two and three-year fixes

For two-year fixes, Market Harborough Building Society has one of the best mortgages, priced at 2.69% for those with a 25% deposit. However the fee is higher than the N&P deal, at a hefty £1,595. HSBC also have a competitive two-year fixed rate at 2.54% with a £1,999 fee – though you will need to stump up a 40% deposit.

Turning to the three-year rates, Yorkshire Building Society has a slightly cheaper mortgage than N&P, priced at 2.94% and available to those with a 25% deposit. However the fee is again higher, at £995. If you can afford to put down a larger deposit - in this case 30% - Chelsea Building Society could be a good choice. It is offering a 2.79% deal with a £1,895 fee. First Direct also has a three-year fix at 2.88% for those with a 35% deposit. But again, the fee is fairly hefty, set at £1,499.

So all is relatively rosy for two- and three-year fixes on the price front – but what about their practicalities in the current financial climate?

Base rate movements

There are two factors to keep in mind when shopping around for a fixed mortgage, along with how long you intend to stay in the property for of course. First is future base rate movements, and second is the impact of wider economic uncertainty on mortgage prices. Essentially, you – and your mortgage broker – need to assess what state the mortgage market will be in when your fixed rate falls away. This is where a potential problem with two- and three-year mortgages arises.

Many commentators and economists are forecasting that the base rate will now stay at its current historic low of 0.5% for another two to three years. Earlier this month, Vicky Redwood, UK economist at Capital Economics, told lovemoney.com that “the chances are pretty good of interest rates staying low [for another three years]”.

This outlook is supported by the recent dip in inflation – a fall that is predicted to continue, taking the CPI measure to below the Government-set 2% target.

So how does this factor into picking a fix?

Picking a fix

If you opt for a three-year term, and the base rate rises two to three years in, you will find yourself shunted back onto a Standard Variable Rate that – in all likelihood – will be far pricier than it is now.

As a result, remortgaging will probably be high up on your to-do list. And this is where a second issue arises. If the base rate is hiked, the mortgage market will almost certainly price up, increasing your remortgaging costs.

But even if the base rate remains at 0.5% when your fixed rate comes to an end, there’s still no guarantee that the market will be anything like as competitive as it is now. According to data from Moneyfacts.co.uk, two-year fixed rates have increased every month since September 2011. This is down to lenders taking on an increased cost of financing loans, a rise being primarily driven by economic instability, both here and in the Eurozone.

Just think; if mortgage costs are increasing now – when many are pushing back their predictions for a base rate rise to 2015 – what will they be like in two to three years’ time?

Indeed, you could find that a two- or three-year fixed rate mortgage, while cheap now, will leave you just as you need it the most. So what alternatives are out there?

Your other options

If you don’t fancy a medium-term fix, two other options are to go the way of the tracker, or to lock in for longer.

Trackers have the advantage of offering a lower initial rate. However they are variable, so you need to be sure that you can budget in any repayment increases. Two- and three-year term trackers will offer the lowest price. But as with the short fixes, you’ll be shunted back onto a potentially pricey SVR when the term runs out.

A better option is a lifetime tracker. You’ll pay a little more in interest. However, your rate will always be linked directly to the base rate, unlike an SVR. So when the base rate does rise, your mortgage will increase in cost by the same amount. At this point – depending on the state of the market – you may want to remortgage.

Alternatively, you could fix for longer than two to three years. Five-, seven- and even ten-year fixes have been coming down in price recently. These allow you to lock into a competitive rate for the long term, guaranteeing your monthly payments remain stable, even if the market is pricing up.

Ten alternatives to the short-term fix

More: ‘Base rate to stay low until 2015’ – what to do now! | Tracker mortgages are still very cheap: don’t be scared into fixing your mortgage rate

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At lovemoney.com, you can research all the best deals yourself using our online mortgage service, or speak directly to a whole-of-market, fee-free lovemoney.com broker. Call 0800 804 8045 or email mortgages@lovemoney.com for more help.

This article aims to give information, not advice. Always do your own research and/or seek out advice from an FSA-regulated broker (such as one of our brokers here at lovemoney.com), before acting on anything contained in this article.

Finally, we tend to only give the initial rate of a deal in our articles, but any deal which lasts for a shorter period than your mortgage term may revert to the lender's standard variable rate or a tracker rate when the deal ends. Before you take out a deal, you should always try to find out from your lender what its standard variable rate is and how it will be determined in the future. Make sure you take all this information into account when comparing different deals.

Your home or property may be repossessed if you do not keep up repayments on your mortgage