Personal Finance

Navigating the mortgage minefield: should you get a fixed rate, variable rate or tracker mortgage?

Getting a mortgage is one of the biggest financial commitments you're likely to make during your lifetime. With dozens of UK lenders offering hundreds of different mortgage loans, how do you choose the deal that will suit you best?

Choosing a mortgage in the UK can be overwhelming. If you’re a first-time buyer who’s never had a mortgage before, it’s difficult even to know where to start. We’re bombarded by hundreds of different types of mortgage product being offered by traditional high street banks and building societies, as well as by plenty of overseas banks and other lenders.

Unless you win the lottery or receive a huge windfall, chances are you’ll be making mortgage payments for much of your working life—the average household with a mortgage owes over £135,000. It’s therefore essential to choose a mortgage with the right type of interest rate that will both be affordable for you, as well as save you money as much money as possible.

That means understanding your options, and what the different types of mortgage are, and how they work. Welcome to the mortgage minefield!

Mortgage basics

The word mortgage is actually an Old English word derived from two French words, mort and gage, literally ‘dead pledge.’ Not a lot of people know that…

Without getting into the legal jargon, a mortgage is a document in which a property owner pledges the property as security for a loan. If the borrower stops making payments on the loan, then the lender has the legal right to sell the property to recover whatever money is owed by the borrower.

This is why you’ll always see the following in any marketing for mortgages, something along the lines of “Your home is at risk if you do not keep up repayments on a mortgage or other loan secured on it.

So, now we’ve got the health warning out of the way, let’s get into the nuts and bolts of mortgages.

How are mortgage rates set?

When you’re searching for a mortgage, one of the first decisions you’ll need to make is what kind of interest rate to choose.

The interest rate will affect how much your mortgage loan repayments will cost you each month. Obviously, the higher the interest rate, the more you have to pay.

The rate can be set in several different ways. Some are guaranteed to stay the same for a number of years, some can change at any time, and others are tied to the Bank of England base rate.

The base rate is how much the Bank of England charges to lend money to banks and building societies. Lenders use this as a reference for some of their own interest rates, which will go up or down when the base rate changes.

The Bank of England base rate is currently 0.75%. The chart below shows how it has changed over the past decade:

chart showing history of Bank of England base rate

Every bank and lender will then set its own standard variable rate (SVR), which is the interest rate they will put you on after any limited-term mortgage deal ends. Lenders have a single SVR for all borrowers, and they can change it whenever they want to. At the time of writing (August 2019), most SVRs are around 4.00-5.00% in the UK. The table below shows current SVRs for the 10 largest UK mortgage lenders:

LenderStandard Variable Rate (SVR)
Lloyds4.24%
Nationwide B/S4.24%
RBS4.24%
Santander4.00%
Barclays4.24%
HSBC4.19%
Coventry B/S4.99%
Virgin Money4.99%
Yorkshire B/S4.25%
TSB4.24%
Average:4.36%

So the SVR is where it all starts. However, there are many different types of mortgage loans available. Let’s look at some of the key features of and differences between fixed, variable, tracker and capped mortgages.

What are the different types of interest rate?

1. Fixed rate mortgages

As the name suggests, the interest rate on these loans will not change for a fixed period: perhaps one, two, three, five or even ten years.

This means that the amount you pay each month will stay the same until the fixed rate period ends. Even if the lender’s SVR or the Bank of England base rate goes up, your mortgage is unaffected and you’ll pay the same amount until the end of the fixed term. The downside is that if interest rates go down, you will not benefit from any mortgage rate reduction while you’re locked into the fixed rate.

When your fixed rate finishes you will move onto the lender’s SVR, unless you move to a new mortgage deal (potentially with a different lender) at that point.

Example: You take out a mortgage fixed at 4% for five years and your lender increases its SVR after one year. You will continue to pay 4% for another four years, regardless of your lender’s SVR.

Pros
  • Rate is fixed
  • Repayments stay the same
  • Most expensive initial and early redemption fees
Cons
  • Your rate does not fall even if the SVR does

The table below shows some current 2-year fixed rate mortgage deals offered by the 10 largest UK mortgage lenders. Notice how low they are, compared to each bank’s standard variable rate. These ‘teaser’ rates are designed to be attractive to potential borrowers, who the lenders hope will stay with them once the fixed rate period (in this case, 2 years) ends and they can then be switched to a much higher standard variable rate.

Fixed Rate vs Standard Variable Rates in the UK
LenderStandard Variable Rate (SVR)2-Year Fixed Rate
Lloyds4.24%1.75
Nationwide B/S4.24%1.59
RBS4.24%1.51
Santander4.00%1.49
Barclays4.24%1.55
HSBC4.19%1.34
Coventry B/S4.99%1.55
Virgin Money4.99%1.72
Yorkshire B/S4.25%1.54
TSB4.24%1.59
Average:4.36%1.56%

Source: ww.moneysupermarket.com, as at 05-Aug-2019

Variable rate mortgages

Again, as the name suggests, the interest rate can rise or fall whenever the lender decides. When the rate goes up, your monthly payments will increase; as the rate falls, your repayments will go down. You see, mortgages really aren’t so complicated…

A lender’s SVR will loosely track any changes in the Bank of England base rate, but lenders are not required to track the base rate exactly.

Example: You take out a variable mortgage at 4.5% and the Bank of England later raises the base rate by 0.75%. Your lender then decides to increase your rate by 0.5% to 5.0%, so you’ll pay more each month.

Pros
  • Can be cheaper than fixed deals
  • Usually no early repayment charge
  • Rates can rise or fall at any time
Cons
  • Rates can rise or fall at any time
  • No guarantee that rates will ever fall

Tracker rates

Tracker rates are variable and go up or down every time a key benchmark like the Bank of England base rate does. Your lender has no discretion, and your interest rate will change by exactly the same amount.

Example: You take out a mortgage that pays base rate plus 2%. The base rate is 0.75% at the start, so your rate is 2.75%. If the base rate goes up by 0.5% to 1.25% after six months, your mortgage rate would change to 3.25%.

Tracker rates usually last a fixed number of years. After that period ends, you’ll usually be switched to the lender’s SVR, which is often higher (unless you switch to another type of mortgage loan).

Pros
  • Full transparency—rate is tied directly to the base rate
  • Your interest rate can fall with the base rate
  • Deals can last for several years
Cons
  • If the base rates rise, yours will too
  • Could charge high rates for years

Other Types of Mortgages

To recap: fixed, variable and tracker are the main types of mortgage interest rate. There are some others, such as:

  • Discounted rates: offer a short-term discount, maybe for one year, of say SVR less 2%; and
  • Capped rates: guarantee your mortgage rate will never go above a certain level.

But these kind of mortgage deals are almost always variations on a theme of one of the three core mortgage types.

Which mortgage type is best for me?

Choosing a mortgage with a particular type of interest rate can save you thousands, but there is no obvious right or wrong answer as to which one is ‘best’. It all depends on whether the Bank of England Base rate goes up or down, whether you’re affected by those changes (depending on whether you’re on a fixed or variable rate), whether you’re likely to move house within a few years, and so on.

When interest rates go up, borrowers on fixed rate mortgages are usually happier because their mortgage rate and repayments do not change. And when rates go down, it’s borrowers on variable rate or tracker mortgages that are usually happier because their mortgage rates will also (usually) fall.

If interest rates stay the same for long periods, variable, tracker or discount rates are usually better because they often start with lower interest rates and charge lower fees than fixed rate mortgages.

Of course, no one has a crystal ball and it’s impossible to predict how the Bank of England base rate will move, since it depends on the wider economy, including variables like inflation, unemployment and the Bank of England’s predictions as to the future direction of the UK economy.

So what kind of mortgage should I get?

Since it’s impossible to predict future interest rates, it makes most sense to base your decision it on your own financial situation:

  • If you can afford the risk of rates going up and can easily afford your mortgage repayments (and you think rates are more likely to stay put or go down), a variable, discount or tracker rate could give you a lower starting rate and a chance that it might work out cheaper overall.
  • But if you think you might struggle to afford higher repayments if rates go up, getting a fixed rate mortgage might be better since you’ll keep paying the same amount for the fixed term, regardless of what happens to the base rate.

The final word

The best advice on mortgages is to keep checking what offers are available from all the different lenders. The market changes constantly and all kinds of different deals and incentives will be offered by banks and lenders depending on how competitive (aggressive) they want to be, whether they’re trying to grow their share of the mortgage market, and many other factors.

It’s important to check early repayment fees before you sign your mortgage documents. If you think there’s a good chance you’ll be moving house within 2-3 years (especially if you are still in your mortgage’s introductory or fixed rate), make sure you know whether there will be a fee for early repayment, and whether you’re comfortable agreeing to it.

Make use of the comparison sites to get a feel for what mortgage loans are available. Here are a few:

And don't be afraid to get some help and advice from a mortgage broker or independent financial adviser (IFA) if you think you need it. You can also check out The Money Charity, which provides great information and advice on all kinds of money matters for young people and adults.

Getting a mortgage is a decades-long commitment, so it’s important to do your research and get it right.

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