Many borrowers are unaware that it is often possible to borrow larger amounts if you agree to a 5 year fixed rate with your lender. This is because lending institutions are not required to stress test borrowers’ repayment capacity is they decide to take out a mortgage on a 5 year fixed rate.
Under guidelines as set out by the Financial Regulator, when processing applications for variable rate mortgages, lending institutions are required to test the borrower’s repayment ability in face of an increase in interest rates of 200 basis points. This means that if a borrower wishes to take out a variable rate mortgage at a rate of 4.75%, then their application will be stress tested to ascertain whether the borrower could cope with repayments at a level of 6.75%.
Many borrowers choose to buy properties that already require them to stretch their income. This process of ‘stress testing’ applications often means that many borrowers are refused the amounts they wish to borrow on the basis that they would not be capable of making repayments at a rate of interest that is 2% higher.
This stress testing procedure is not applied to 5 year fixed rate mortgages. This is due to the rate being fixed for the entire 5 year period, thus remaining unaffected by any further increases in interest rates. Lenders therefore make the assumption that the applicant will be equally as capable of making the same repayments in 5 years’ time.
However something to be aware of is that 5 year fixed rates are somewhat higher than standard variable rates. Although they do vary with respect to different lenders, most 5 year fixed rates currently exceed 5%, with variable rates at a lower level. It is worth remembering also that if you agree to a 5 year fixed rate mortgage and interest rates fall within that period, you are still obliged to make your repayments at the rate initially agreed.
If you decide that you would like to switch to a variable rate during the fixed term, a penalty will be incurred. This penalty is typically calculated taking the length of the term remaining into consideration. The penalty will usually be higher the longer is left on your term.