A Guide to Variable Rate Mortgages

What is a Variable Rate Mortgage?

A variable rate mortgage is a type of mortgage in which your monthly repayments are not fixed but can change at any time. This means that your monthly payments could go up or down.

Variable rate mortgages can be tied to the Bank of England base rate or in some cases the rate is set by the lender themselves.

Interest rates are usually affected by the state of the economy. If inflation and growth are running rife then interest rates are usually increased to discourage people from spending and encourage them to save. Higher interest rates usually make people less likely to want to borrow extra money.

However, during economic downturns, interest rates usually go down in an effort to get people to borrow and spend money.

As a result, variable rate mortgages are impacted by the state of the economy.

What Are the Different Types of Variable Rate Mortgage?

There are three main types of variable rate mortgage: tracker mortgages, standard variable rates (SVR) and discounted variable rates.

Tracker Mortgages

A tracker mortgage is linked to a fixed economic indicator, most commonly the Bank of England base rate (also known as the Bank Rate), usually with a small percentage added on top of this. For example, the Bank of England bank rate might be 0.1% and the mortgage might track this rate plus 1% which would give a total rate of 1.1%.

This means that if the Bank of England bank rate goes up or down, your monthly mortgage payments will go up or down in line with it.

Most tracker mortgages will include an interest rate collar which is a bottom limit under which the rate won’t drop, even if the Bank of England’s rate goes below it. This type of deal works in the lender’s favour by stopping monthly payments from becoming too low.

Other tracker mortgages might be capped, which means that there is a top limit to the amount your interest rate can rise. These types of tracker mortgage are however quite rare today.

The rate you pay on a tracker mortgage will usually change the month after any movement on rates by the Bank of England.

For some time the Bank of England base rate has been very low and so those with existing tracker mortgages have benefitted from low interest rates.

However the Bank of England base rate could change at any time and so it is important that you understand that with a tracker mortgage your monthly payments could increase unexpectedly.

What Are the Pros and Cons of a Tracker Mortgage?

Currently with the Bank of England base rate at such a low level and with little scope for further reduction, tracker mortgages do not look so attractive, especially as many lenders are offering fixed-rate deals at a comparable rate. But what are the advantages and disadvantages of a tracker mortgage?

Advantages:

• If the Bank of England bank rate falls then your monthly repayments will reduce in line with this.
• The Bank of England bank rate has been very low for more than a decade now and so many tracker deals offer attractive rates, however the only likely direction for a tracker mortgage to move is up.

Disadvantages:

• If the Bank of England bank rate goes up so will your monthly repayments.
• It can be harder to budget with a tracker mortgage, as you can’t predict what your monthly mortgage payments will be in future.
• If you want to leave your mortgage deal early you might have to pay early repayment charges (ERC).

Standard Variable Rate Mortgages

A Standard Variable Rate (SVR) is an interest rate set by a lender. They do not track in relation to the Bank of England bank rate at a set percentage – they can move up and down according to the whims of your lender.

Standard Variable rates are often expensive so are rarely selected as a starting mortgage deal, instead it is usually the rate you will find yourself on after your set period mortgage deal, such as a fixed rate mortgage or discounted deal, ends.

To avoid going on to a standard variable rate after your mortgage deal ends you can remortgage to secure a better deal, or arrange a new deal with your existing lender (known as a product transfer).

What are the Pros and Cons of a Standard Variable Rate?

Most people encounter standard variable rates because it is the rate they revert to after their mortgage deal has ended, but what are the advantages and disadvantages of a standard variable rate?

Advantages:

• They generally do not have early repayment charges attached so if you want to overpay, pay off your mortgage early or remortgage this can be attractive.

Disadvantages:

• Standard variable rates are generally more expensive than tracker or discounted rates.
• Your monthly payments could increase if the lender chooses to increase the rate.
• Your interest rate could be changed at any time.

Discounted Variable Rates

Discounted mortgages are offered at a discount rate of the lender’s standard variable rate for a set period of time. However, it is important to remember that the lender’s standard variable rate can change at any time so although your deal would be pegged at a set percentage below the SVR the amount you pay each month could increase if the SVR goes up.

Discounted mortgages are usually offered for between 2 to 5 years.

They are based on the lender’s standard variable rate so the bigger the percentage of the discount does not necessarily mean a better deal. For example, if one lender is offering a 2% discount off their SVR of 6% then the rate you will get is 4%, however another lender might only offer a discount of 1% but their SVR is 4% meaning you’d actually get a rate of 3%.

This is where a good mortgage advisor comes in as they can examine all the discounted rates available to make sure you get the right deal for your circumstances.

What Are the Pros and Cons of a Discount Variable Rate Mortgage?

Advantages:

• A lower interest rate than your lender’s standard variable rate for the set period of the deal.
• If the lender cuts their standard variable rate then your monthly repayments could reduce.

Disadvantages:

• It can be harder to budget because the rate could increase as lenders can change their SVR at any time.

Key Things to Consider When Selecting a Variable Rate Mortgage

Some of the things you may wish to consider before selecting a variable rate mortgage include:

• Will you still be able to afford the monthly repayments if they increase?
• Would a tracker, discount or standard variable rate be the right fit for you?
• How much you can afford to spend on set-up fees?
• Are any early repayment charges?