Time for a tracker?
Fixed rates plunge in popularity as borrowers take a chance on variable rate mortgages. Christina Jordan explains…
Fixed rate mortgages have long been the darlings of UK mortgage borrowers. In June this year for example they made up 78% of all lending according to the Council of Mortgage Lenders.
Borrowers have traditionally preferred setting their rate in order to get complete security of payments, allowing them to budget and plan ahead. After all, a fixed rate remains the same for the agreed duration no matter what happens to interest rates.
But now many people - 75% according to broker John Charcol - are eschewing the safety of a fix for the low variable rates currently on offer. These mortgage rates move up and down as a result of interest rate movements and include trackers, discounted rates and standard variable rates.
What's so great about variable deals?
At the moment variable deals are priced significantly lower than fixed rate mortgages, tempting borrowers looking to minimise their monthly repayments. For those with a 25% deposit for example there are a host of tracker deals under 3%, compared with nothing for those who want to fix. One of the cheapest two-year fixed rates is 3.69% from Abbey.
So it's little wonder borrowers are flocking to variable rates in their droves, but which type should you go for?
1. Trackers
The most dominant type of variable rate mortgage works in a very straightforward way. Your rate literally tracks the Bank of England Base Rate (currently 0.5%) at a set margin - for example Base Rate plus 2.5% would mean a payrate of 3%. Your rate moves up and down in line with Base Rate, always maintaining your margin.
Borrowers like trackers because they are transparent. If Base Rate moves, you know exactly what's going to happen to your mortgage. Plus they are cheap - a short-term deal like Northern Rock's two-year tracker for those with 30% upfront is just 2.59%, or if you only have a 25% deposit ING Direct offers 2.79%.
2. Standard variable rates (SVRs)
These are lenders' default rates that many customers revert to at the end of a discounted or fixed rate deal. They are currently extremely competitive because of historically low interest rates and, as a result, many are not available to new borrowers, only existing clients.
Like trackers they move up and down in response to Base Rate changes but the crucial difference is that the lender can choose whether or not to pass on a Base Rate cut or increase - there is no set margin like with a tracker. In other words the lender has more leeway which can work in your favour if it decides not to pass on a rate increase or, against you if it chooses not to pass on a cut.
If you are an existing borrower coming to the end of a fixed or discounted deal it might be cheaper for you to revert to your lender's SVR than to find a new deal - lucky Lloyd's TSB borrowers for example will revert to its SVR of just 2.5%. But it's always worth checking the best remortgage deals on offer.
3. Discounted rates
These are simply a temporary discount from the lender's SVR, for example a 2% discount off SVR for three years, after which you move onto the SVR.
Discounts are currently priced similarly to trackers, but because they are linked to your lender's SVR not to Base Rate they will not necessarily follow every rate change exactly. Purchase customers with a 20% deposit could consider HSBC's new two-year discount mortgage at 3.59%, which is also fee-free.
Ticking time-bomb?
The biggest consideration with any variable rate is the fact that it has potential to rise if the Bank of England decides to increase interest rates. And with the Base Rate at a current record low of 0.5% it's pretty clear that the only way is up.
This could have a devastating impact on your finances if you have not factored in the possibility of increased repayments. For example…
Say you take out a 25-year £150,000 repayment mortgage on a 3% tracker deal, priced at Base Rate plus 2.5%. Your monthly repayments would be £711.
If Base Rate rose to 1.5% your pay rate would increase to 4% and your repayments to £792 a month - an increase of £81.
If Base Rate rose to 5% (remember it was at this level or higher for most of last year!) your pay rate would increase to 7.5% and your repayments would shoot to £1,108 - a massive increase of £397 a month. Could you afford that?
But when exactly will rates rise?
The short answer is that nobody knows. But the general consensus among economists is that rates will remain at their current low until at least the middle of next year - one of the reasons variable deals are so attractive.
Of course, there are no guarantees and rates could rise sooner, plus there is no cap on how high they will go. It's essential to factor in significant future increases when looking at any variable rate mortgage, be it tracker, SVR or discounted rate.
Many people find the help of a specialist broker invaluable when trying to make a decision and find the right mortgage for them.
**Articles featured on BeatThatQuote.com are for information purposes only and reflect the views of individual writers. Articles are not, and should not be considered as, financial advice. BeatThatQuote.com strongly encourages our readers not to rely solely on information contained within this article/our website, but to conduct their own research and seek independent advice about the financial products they purchase.**
Categories
