This year, hundreds of thousands of homeowners will be hit with a financial shock.
Around 1.6 million fixed mortgages expire in 2026. Many of the owners will find their bills rise, possibly by hundreds of pounds a month.
Rates have been soaring since March, as a result of the conflict in the Middle East and its expected impact on inflation and Bank of England interest rates.
But this sort of shock is not rare – not even in recent memory.
Most borrowers will remember the infamous Liz Truss mini-Budget in 2022, which sent average mortgage rates flying upwards by around 2 percentage points with hundreds of products pulled from the market.
And sudden increases in rates have been common since. Most noticeably when inflation remained stubbornly high in the summer of 2023, and two year deals peaked at 6.85 per cent on average.
So when these mini-mortgage crises are becoming a common occurrence, why do British households continue to take the gamble?
Over the past seven years collectively, UK Finance data shows that more than nine in 10 new mortgages were taken out on fixes between two and five years. Meanwhile, fixed deals of over five years make up around just two per cent of the market.
It means that, although most households know what their bills are now, in half a decades’ time or less, they face the unknown. Whilst rates could come down, there is also the risk they increase significantly.
But it doesn’t have to be this way. Other major economies, the United States being the key example, operate on dramatically different systems, where fixing your mortgage rate – and guaranteeing your monthly bills – for the lifetime of your home loan is commonplace.
This avoids the biennial panic and market monitoring some in the UK face.
So why doesn’t the British mortgage system follow the example from across the pond, and move towards a system where 30-year fixed mortgages become the norm – protecting us from so-called “black swan” events like the Iran war, which can shock financial systems?
Why does the US system differ from the UK?
Around 90 per cent of US mortgages are sold on 30-year fixed rates.
“It is extremely uncommon for the initial term of a mortgage to be under five years,” explains Michael Fratantoni, chief economist at the Mortgage Bankers Association, the trade group representing the real estate finance industry in the United States.
Some high-income individuals do take what are known as adjustable rates – similar to fixes here in the UK – but these tend to be for around seven years.
Part of the reason for the difference in the UK and US systems is the way that mortgages are funded.
In the UK, when someone takes out a mortgage with a bank, it tends to keep the loan on their balance sheet and fund it using customer deposits – mainly savings.
This is relatively straightforward if you’re selling a rate for two or five years – you can probably predict what sort of income you’ll have coming in – but it’s more difficult looking 30 years ahead.
In the US, most banks use something known as securitisation. Essentially, pools of mortgages are packaged together and sold as investments, so they’re no longer the problem of the lender.
The US has set up an entire system for this. Two government-sponsored enterprises, colloquially known as Freddie Mac and Fannie Mae, buy mortgages, pool them into these investments – securities – and sell them to private investors.
Three quarters of US mortgages operate this way.
“We’ve created this whole structure to support this market,” explains Fratantoni.
“If you have a bank-based system like in the UK, you’ll necessarily lean towards more [shorter fixed or variable rates] or you’re putting too much stress, in terms of asset liability management, on the banks,” he says.
What does it mean for households?
In the US, most households take on these 30-year loans, but they do pay higher rates than UK customers do, in general.
Rates still fluctuate, but it means once locked in, US households that already have mortgages are protected from things like the current inflation crisis, which can send mortgages upwards in price.
Borrowers can refinance, unlike in the UK where you are usually tied into your fix for its duration.
The US sees large numbers of people refinancing when rates drop, although they never get as low as they do in the UK.
“The expectation is a borrower getting a fix at 6.5 per cent today will have opportunities to refinance at a lower rate. What we see in the US is these refinancing waves. When rates drop they all refinance at once – we get enormous amounts of activity,” explains Fratantoni.
“But there’s no free lunch, investors are going to asked to get paid for this,” he says.
This is reflected in the rates. In summer 2020, as interest rates dropped globally for the pandemic, UK rates could be locked in for below 2 per cent.
Average two-year rates in the UK reached 1.99 per cent. At the same time, US figures from the Freddie Mac suggest average rates were around 3 per cent.
Would Britons take US style mortgages?
Longer fixed rates mortgages in the UK do exist – with the likes of April Mortgages and Perenna offering them – but they are uncommon.
“For a bank to fund a longer duration fix, it will either charge a premium it views matching the internal funding risk, or have assets that match the maturity. This in part explains the prevalence of two, three and five-year fixed rates in the UK,” explains Peter Stimson, head of mortgages at UK lender MPowered.
When they are offered, they have not tended to be massively popular.
Chris Sykes, property finance specialist at MSP Financial Solutions, explains: “The flaw of these long terms rates is the premium charged on them. Often this premium is 1 per cent over a two or five-year fixed rates on the market, on a £350,000 mortgage that is £3,500 per year, or around £291 per month.
“That is a hard pill to swallow for many when they are having to stretch themselves just to get on the ladder.”
Sykes says there is a place in the market for these products, and he has some customers on them.
“Clients who took these back when the rate you could achieve on them was 2 or 3 per cent are now laughing. I just can’t see them being wildly popular until we are in a stable lower rate environment, or they came down in price,” he says.
Rachael Hunnisett, director of Mortgage Distribution at April Mortgages says she believes that longer fixes can “play an important role” in stopping some of the payment shocks seem in recent years.
She accepts that rates are higher than some of the shorter fixes on the market but argues “the value of certainty, avoiding repeated refinancing costs, and reducing exposure to rate spikes can mean they deliver better overall value.”
Asked which system is better Fratantoni says “there are trade offs to both systems.”
“But in a world where rates fluctuate quite a bit, the US consumer benefits from this 30-year fix. They have the protection but the opportunity to refinance,” he adds.
