As interest rates rose, the popularity of variable rate mortgages declined. But given forecasts of a base rate cut this year, can variable deals such as tracker mortgages once again offer a suitable alternative to fixed rates? We discovered…
It is automatic – especially in these times of high interest rates – that when choosing a mortgage deal, borrowers opt for fixed interest rates and ignore variable deals.
The certainty that you know exactly what your monthly repayments will be for a certain period is very attractive. And because variable rates are directly influenced by the Bank of England’s base rate, fixed rates are currently slightly lower.
It’s completely understandable that the variable rate will fall under most people’s radar.
But that doesn’t mean you should rule them out completely.
Indeed, there are certain circumstances and situations where this can be a smart option and even if you are completely convinced of a fixed rate, it is worth knowing more about the alternatives for the future.
Here you can read more about variable rates and who they are suitable for.
What are variable rate mortgages?
These are, as we said, mortgages where the interest rate moves up or down in accordance with a specific rate, such as the Bank of England base rate or the lender’s own ‘bank rate’ – also known as the standard variable rate.
There are different types of variable interest rates. The most common one you will encounter when you are in the process of taking out a mortgage is a so-called tracker interest rate.
This takes the form of a fixed rate – for example 1.5% – plus a base interest rate. With a base interest rate currently of 5.25%, this means that a borrower would pay 6.75%.
Standard Variable Rates (SVRs) also fall under this category. These are set by your lender and apply to anyone who has a mortgage agreement that has expired and not been renewed. You will automatically return to this rate until you find a new deal. They can be changed by the lender at any time and are usually influenced by the base rate.
According to Moneyfactscompare.co.uk, the average SVR is currently 8.17%. Compare this to the average two-year fixed rate, which is 5.79%, and the typical two-year tracker which is 5.95%, and you’ll get an idea of where they all sit on the price charts.
The other type of mortgage with a variable interest rate is a so-called discount interest rate. This takes the lender’s SVR and adds a discount – for example 1.5%. For a lender with an SVR of 8%, a borrower would therefore pay 6.5% on his loan. Due to variable rates, this can change at any time.
How popular are variable rate mortgage deals?
According to UK Finance, 96% of new residential mortgages are currently taken out with a fixed interest rate.
But Dean Scott, proposition and distribution director at Newbury Building Society, explained this had not always been this way.
Between 2005 and 2013 this figure was 37% and in 2010 it exceeded 50%.
“The reductions in bank base rates in 2008 and 2009 have made variable rates extremely attractive to customers,” he says. “With inflation slowing and many commentators predicting we could see rates fall in August or September, is this the right time to think more seriously about variable rates?”
The disadvantages of variable rate mortgages
If it’s something you’re ‘seriously considering’, it’s worth being aware of the potential pitfalls. Having an unpredictable interest rate isn’t the only reason to be cautious with variable interest rates.
“Variable rates are a little harder to understand,” Scott said. “Is it a tracker, is it a discount, is it the standard variable interest rate, is there an early repayment fee or not, someone said I could pay more, and why are you talking to me about floors and ceilings… it’s all just a bit too much compared to the simplicity of a fixed rate.”
Additionally, with interest rates currently high, variable mortgages are more expensive than their fixed-rate counterparts.
The benefits of variable rate mortgages
An important advantage of variable rates is that they are usually not as restrictive and can offer flexibility to customers who do not like to be tied down.
Most fixed rates are inclusive early repayment costs. So if you commit to the current five-year fixed rate, which averages 5.40% according to Moneyfactscompare.co.uk, and rates fall over the next year, you will be charged a penalty if you leave this deal and switch to a cheaper rate . An. But this is not the case with SVRs or many trackers.
Scott said some customers may find this is exactly what they were looking for.
“Lenders have often taken a more flexible approach to moving away from a variable product early,” he said, “and anecdotally, customers tell us that when interest rates rise, they feel they are more manageable with a variable rate.
“Customers can absorb the increases gradually, rather than the sudden demand and payment shock of moving away from a flat rate.”
Scott made another point. “The other thing that has made variable rates attractive to customers in the past is the difference in interest rates,” he explained, “where customers can visualize one, two or maybe even three bank rate changes of 0.25% before they hit the price. of a fixed rate.
“We are not necessarily in this position today, but it may only be a matter of time before we are.”
How to decide if you should get a variable rate mortgage
We’re not writing this section to convince you to take out a variable rate deal, but to help you understand how they work so you’re aware of the alternatives to fixed rate deals.
In our recent article Which mortgage is better? A fixed interest rate of two or five years? the experts interviewed suggested that a tracker or variable product could be a stopgap solution for someone who wanted to lock in their interest rate but wait to see if interest rates would fall.
But this suggestion came with a strong warning. If you stay on your SVR, which can be as high as 8.17% for months, it could cost you quite a bit extra.
Scott added: “Ultimately, whether a variable rate mortgage is suitable for a customer will depend on his or her personal financial circumstances, and mortgage brokers and mortgage advice play an important role in this.
“Even if they are not suitable for some customers, it is clear that variable rate mortgages have the potential to deliver savings for customers when interest rates fall, and it feels like we are now at the precipice of that moment.
“A cut in the base rate by the banks will likely be the shock that customers should seriously consider when it comes to variable rates. Only time will tell whether some customers will move ahead of the bank rate.”