Despite availability from a handful of lenders, long-term fixed mortgages have been slow to catch on in the UK. Around 1% of all mortgaged households have a fixed term over 5 years. This is predominantly because rates on long-term deals tend to be a little higher given the ‘certainty premium’ attached.
SHORT TERM
As you can see from the chart below, for most of the last 30 years, mortgage payments have been cheaper in the first year of a term on 2 and 5-year fixes rather than 25-year deals. For example, the average first-time buyer who took out a 90% loan-to-value (LTV) mortgage between 2010 and 2020 that was fixed for 25 years will have paid £1,592 more in their first year compared to someone taking out a 2-year fix. This was because of an expectation that rates would rise over the medium to long term. Given the cost difference, and without hindsight that rates would rise to where they are today, there was very little appetite for such products.
However, those sums flipped unexpectedly in September 2021, post-mini Budget. At this time, it was expected that rates would have to rise quickly, before falling again over the longer term, which runs counter to much of the last 20-30 years. Consequently, mortgage rates were higher on short-term deals. That gap peaked in September 2022 when the average first-time buyer would have saved £3,867 on mortgage payments in Year 1 by taking out a 25-year mortgage instead of a 2-year mortgage.
More recently, the 25-year certainty premium has been restored and the sums have returned to their historical norms. In February 2024, a typical first-time buyer would spend £1,022 more in year 1 mortgage payments by taking out a 25-year v 5-year fixed-rate mortgage.
There is an argument, however, that these measures could help more first-time buyers onto the housing ladder. This is because, by fixing for 25-years, lenders wouldn’t necessarily have to stress test buyers at higher interest rates, or if they did those tests could be looser. This might then help some households meet the affordability criteria to become homeowners. However, even without stress testing, meeting the affordability requirements can still be a challenge with rates where they are today.
LONG TERM
But what about feasibility over the long term? This is dictated by whether interest rates followed their anticipated path or not.
Since the 1990s, markets have generally been fairly poor predictors of future interest rates. While they thought rates would fall from where they were in the early 1990s, they didn’t foresee the scale of the falls. And it was a similar story in 2007, with markets oblivious to the forthcoming decade and a half of rock bottom interest rates. In most cases, this made 25-year fixed-rate mortgages painfully more expensive.
Over a full mortgage term, someone who bought in the early 1990s faced paying 50-60% more for 25 years of certainty compared to someone who rode out a series of shorter-term fixes. However, this gap has been shrinking, with the certainty premium falling to 20-30% for those buying in the late 1990s or early 2000s.
The arithmetic on long-term fixes only really started to work more recently, given the unexpected increase in rates witnessed over the last 2 years. If rates stay close to where they are today, 2015-21 will probably turn out to have been a golden window to take out a long-term fix. This is because, at that time, rates were low and were expected to stay low. Markets didn’t price in the scale of rate rises we’ve since seen and so 25-year mortgage rates that were available a few years ago now look cheap compared to rates today.
With markets increasingly coming to the view that interest rates will fall from where they are today, the pricing of two and five-year fixes has once again dropped back below a 25-year fixed rate product. This marks a return to normal, with a certainty premium attached to 25-year fixes.
Where interest rates ultimately settle in the long-term compared to today’s market expectations will ultimately dictate whether a long-term fix works out cheaper or not. In part, this will depend on whether interest rates mirror market expectations or whether the Bank of England is slower than forecast to start the anticipated rate-cutting cycle.
However, with finances already stretched amidst a cost-of-living crisis, it’ll be hard to entice new buyers to pay any sort of premium, particularly a big one, for a long-term fix. Ultimately, the success of 25-year fixed-rate mortgages will probably depend on whether the cost differential can remain competitive, either by virtue of interest rates expectations or the government incentivising those first-time buyers looking for long term certainty.
