When pursuing a mortgage loan, the choice will have to be made between a fixed-rate mortgage and a variable rate or tracker mortgage.
It is an important call to make, as one type of mortgage could prove to be much cheaper than the other. So, what are the things to consider when weighing up these different mortgage types?
The Variable Rate Mortgage
Variable rate and tracker mortgages can both fluctuate from their starting rate.
A tracker mortgage normally mirrors any changes in the base rate. So, for example, a 0.25% cut to the Bank of England interest rate would be passed on to the customer via an equivalent cut to the mortgage rate by the lender.
A variable rate mortgage, on the other hand, can change owing to other factors. A lender might raise its variable rate if it experiences a rise in costs, or lower it if it seeks to become more competitive.
What to consider with variable/tracker mortgages:
- [+] The main advantage of a tracker mortgage is that homeowners can expect to benefit from any reductions in the Bank of England base rate.
- [–] The main disadvantage is that homeowners will be adversely affected by any increase to the base rate, or by a rise in a lender’s variable rate.
- [+] Because the rate is subject to change, prospective customers could benefit from some particularly good deals. Banks and building societies can attract customers with low tracker rates in the knowledge that they can these rates can be raised if circumstances change.
- [–] But for this reason, customers (and especially first-time buyers, on higher initial rates) will need to ensure that they can afford the repayments if the rate does increase.
Undoubtedly, there is an element of chance with tracker or variable rate mortgages. It is difficult to anticipate how the Bank of England base rate will behave over a number of years.
However, the Bank of England’s predictions that the base rate is unlikely to rise until 2016 have been designed to bring more certainty to the markets. Tracker mortgages are the products most likely to benefit from this.
The Fixed Rate Mortgage
With a fixed-rate mortgage, the initial rate remains consistent for an agreed period, normally lasting between two and five years. The rate that you sign up to is the rate that you pay for the entirety of this period.
At the end of the fixed-rate term, the rate reverts to the lender’s standard variable rate. This varies from lender to lender so it could be an important factor to note when choosing a mortgage if you don’t intend to switch again immediately afterwards.
If you decide to cancel your fixed-rate mortgage before the end of the fixed period, you will receive a penalty in the form of an early redemption fee. This will usually be between 1% and 5% of the cost of the mortgage.
What to consider with fixed-rate mortgages:
- [+] A fixed-rate mortgage protects against any increases in the Bank of England base rate. Even if the base rate goes up, your repayments remain the same.
- [–] Conversely, if the base rate goes down – though that’s unlikely at present – tracker rates could move below the fixed rate that you’re subscribed to.
- [+] Establishing a fixed monthly payment for several years makes it easier to budget and offers security to a homeowner.
- [–] Though fixed-rate mortgages have been driven down to record low levels in 2013, arrangement fees have risen significantly, which can make attractive deals expensive.
(See our guide to mortgage arrangement fees for more details.)
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Stick or Twist? Choosing between a variable and a fixed-rate mortgage.
2013: The Year of the Mortgage
Mortgage rates have been driven down in 2013 towards their lowest levels in a generation. It’s a good time to make inroads into repaying your loan, if that’s possible.
If you’re able to remortgage from a 4.5% rate to a 3% rate, for example (whether fixed or variable), using some of the savings on your monthly payment to overpay on your mortgage could save you thousands of pounds on your loan and reduce the term considerably.
(See how much you could save using our over-payment mortgage calculator.)
The caveat is that most lenders only allow a borrower to overpay by a small percentage (max. 10%) on their standard monthly payment before they trigger an early repayment penalty. One of the advantages of offset mortgages is that they offer greater flexibility to repay more without incurring charges.
Fixed and variable rate mortgages both have their strengths and weaknesses, but both should offer some reward for the effort of switching.
Standard variable rates are not always particularly competitive, and it could be possible to halve your interest costs by making the choice to switch in this ultra-competitive climate.
Keith McDonald
Which4U Editor
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