What happens when my fixed rate ends?Easy

The loan does not end — the rate does. What it moves to was written into the agreement at the start, and it is rarely the rate anybody remembers.

3 min read · 535 words

The short answer: at the end of the fixed period the loan continues and the interest rate changes to whatever the agreement says it changes to — usually a variable rate that is higher. Nothing happens automatically except the rate. This page explains the mechanism; it is not advice about any particular loan.

What a fixed period actually is

It is a promise about the rate for a stated number of years, on a loan whose term is much longer. A twenty-five year mortgage with a five-year fixed period is a twenty-five year loan; only the first five years are priced.

The bank funds that promise. It has borrowed or hedged to be able to receive a fixed rate for five years, which is why it cannot simply release you from it early without a cost — see below.

Where the new rate comes from

The agreement names it. Commonly it is a standard variable rate set by the lender, or a rate defined as a margin over a reference rate. The two behave differently: a lender's own variable rate moves when the lender decides, a referenced rate moves when the reference does.

Which one applies, and what the margin is, was in the offer document at the start. It is the least-read paragraph in retail lending and the one that decides the payment for the remaining twenty years.

Why the step can be large

Because a fixed rate agreed years ago reflects the market of that year, and the revert rate reflects this one. If rates rose in between, the two are far apart and the payment steps up on one date rather than drifting.

The arithmetic is worth doing rather than fearing: on a loan of 200,000 with 20 years remaining, a rate moving from 2% to 5% raises the monthly payment from roughly 1,012 to roughly 1,320 — about 308 more a month. The numbers here are illustrative arithmetic, not a quote.

Why leaving early is charged for

An early repayment charge is not a penalty for changing your mind; it compensates the lender for unwinding the funding it put in place. If rates fell, that unwind costs the bank money, which is exactly when borrowers most want to leave.

That asymmetry is the point: a fixed rate is an option the borrower holds. You will want to repay early when rates fall and stay put when they rise, and the charge is what the lender takes for writing that option. See mortgage and consumer credit.

Why the bank cares as much as you do

A fixed-rate book is a bond portfolio wearing different clothes. When rates rise the bank is receiving fixed and funding floating, so its margin compresses — the same arithmetic that makes a bond's price fall. That is why the book is hedged with swaps rather than simply offered, and why why a bond falls when rates rise is the same question from the other side.

The one sentence to take away

The fixed period is a price for part of the term, the revert rate was agreed at the start, and the step between them is the market of two different years meeting on one date.