Trackers and short-term fixed rates are about to become a lot more popular

     Marie Grundy - Managing Director of Residential Mortgages and Second Charges

It’s hard to believe, but by the time you read this it will have been 13 months since the disastrous mini-Budget of the short-lived Liz Truss-Kwasi Kwarteng era.

Budgets often have the power to move markets but I struggle to remember such a negative reaction to one as this one in my entire professional career.  While interest rates were rising pre-Budget, the fallout almost certainly caused the Bank of England to hike rates higher and faster than it probably would have done. 

What happened next has been well documented, but it’s worth combing over the numbers to truly appreciate the impact this fiscal event had on the market. Since the mini-Budget, in September last year, interest rates have shot up 3 percentage points to 5.25% – their highest level since February 2008. Of course, when interest rates rise, mortgage rates tend to follow more often than not – and they certainly have done that over the past year.

At the end of August last year, the average fixed rate was 2.55%, according to the Bank of England. The latest batch of data shows that by July this year the average was 4.58%. To put that into context, on a £250,000 loan, that is a difference of more than £270 a month. Therefore, it’s little surprise that borrower habits have changed somewhat over the past 12 months.

Any broker reading this will be aware that higher interest rates have had a hugely negative knock-on effect for purchase volumes. But that’s to be expected, given the affordability pressures many borrowers are currently facing.  But higher rates have also had a noticeable effect on borrower preferences. In September 2021, a year before the mini-Budget, 50% of borrowers opted for a five-year fix, according to conveyancer LMS. By September 2022, that figure had rocketed to 68%. 

In a rising interest rate environment, borrowers prefer the security of a longer-term fixed rate mortgage – even if they are paying substantially more for than they used to. But how will borrower preferences evolve now that – hopefully – the end of interest rate increases are in sight? 

As we have seen over the past month, the prospect of peak interest rates has caused swap rates to fall significantly, giving lenders scope to reduce their mortgage rates. That could once again alter borrower behaviour. When interest rates first started rising, many commentators said we could see trackers boom in popularity as savvy borrowers looked to profit once interest rates inevitably began to fall again.

However, I felt at the time it was perhaps too soon to make that call. As I said above, when rates are rising, most people want to lock-in to protect themselves not just from rising repayments but also uncertainty.  But if we have now truly reached peak interest rates, which is looking increasingly likely, there is a very good chance we could see trackers and shorter-term fixed rates become more popular again.

Indeed, Twenty7Tec’s latest Mortgage Market Report shows that two-year fixed rates accounted for 45% of all fixed product searches by brokers in August 2023. By comparison,  five-to-ten year fixed rates accounted for just 20.2%, down from nearly 36% a year ago. 

For some borrowers, now may be the perfect time to take out a shorter term fix. For a start, rates have come down and are expected to come down further, and it means they are not locked into a long-term deal . Traditionally borrowers looking for shorter fixed rate terms have opted for two year fixed rates but with cheaper options available through three year fixed rate deals there is  an alternative in between two and five year deals. ..

Similarly for trackers, if rates do start to come down next year or the year after, these borrowers could well find themselves in a better position than if they had fixed for five years.

And if borrowers do start to favour short-term fixed rates and trackers, we may well see a much-needed boost in transaction volumes as a result of greater remortgage activity. Of course, all of this hinges on whether rates are at their peak or not. Either way, it will be interesting to see how the market develops.