With the latest inflation figures publicised by the Office of National Statistics, inflation has been confirmed again as 8.7% in May 2023. This prompts further fears of increases in the bank base rate, which is likely to affect mortgage pricing.
In this blog, we focus on mortgage scheme types, looking at fixed, tracker and variable rate mortgages and the benefits of each type of scheme. With rates likely to continue to rise, fixed rates are likely to be the order of the day. However, for those of a more speculative nature who anticipate that rates will drop in the none-too-distant future and can potentially budget for further increases in payment, a tracker rate may be appealing.
What’s a fixed-rate mortgage?
What are the benefits of a fixed-rate mortgage? The lender agrees to give you a short-term special rate. Regardless of what happens to interest rates, with a fixed mortgage, your repayments are fixed for the length of the deal.
Lenders call this the incentive period – and all fixed deals will have one, whether it’s two, three, five, 10 or 15 years. Sometimes it’s even possible to find fixed-rate deals that last for the life of your mortgage.
Like all mortgage deals, fixed rates have pros and cons:
- Certainty – you know what your mortgage will cost.
- Your payments won’t go up over the life of the fix, no matter how high rates go.
- You’ll know what you’ll pay, meaning you can budget around it.
- ∙ If interest rates fall, you won’t see your payments drop.
- ∙ If you want to get out early, you’ll usually pay high penalties, called early repayment charges.
If a fixed mortgage sounds good, think carefully about how long you want to fix for. Ideally, you don’t want to leave the deal before the initial period ends, as there’s usually an early repayment charge, which can add significantly to your costs.
What is a variable rate mortgage?
With this type of scheme, as the name suggests, the rate and payment will move up and down. The principal reason for this is a change to the UK economy, such as inflation, and underlying costed swap rates, with the monetary policy committee setting the base interest rate.
In times of growth and inflation, interest rates tend to go up to discourage spending (as is happening right now). This is to make saving more attractive and borrowing costlier – meaning people are less likely to borrow to spend. In downturns, interest rates are often cut to encourage spending.
To complicate things, variable rate deals fall into three categories: trackers, standard variable rates (SVRs) and discounts. This is how they work:
Tracker mortgages
Here, the rate tracks a fixed economic indicator, the bank base rate, the Bank of England’s official borrowing rate. This doesn’t mean it’s the same as the base rate, just that it moves in line with it. Tracker mortgages are popular in times of low or falling interest rates (which isn’t the case right now). Here are the pros and cons:
- It’s transparent as you have the certainty that only economic change can move your rate rather than the commercial considerations of the lender.
- Flexibility, ability to make overpayments or switch products generally without penalty.
- ∙ Uncertainty – if rates rise, so will yours.
- ∙ You’re also locked into a fixed relationship, so paying a rate several percentage points above the base rate and interest rates jump could mean substantial future costs.
Tracker mortgage rates usually track above the base rate. For example, a tracker mortgage might track 1%, which would be 3.25%. Currently, the best tracker mortgage rates are around the 3% mark. However, if the base rate was to increase by one percentage point, so would your mortgage.
Standard Variable Rate
A standard variable rate, or lender SVR, is the interest rate that will be charged once an initial deal period on a fixed or tracker rate mortgage ends. With an SVR mortgage, your mortgage payments could change monthly, going up or down depending on the rate.
Discounted Mortgages Rates
A discounted mortgage has a variable interest rate set below the lender’s standard variable rate (SVR).). Usually, a discount deal lasts for 2-5 years, but sometimes they are longer. Because it’s a variable rate, it will change whenever the SVR does, but the discounted percentage remains the same.
Example:
If the lender’s standard variable rate is 6.9% and the mortgage discount is 2%, your initial pay rate will be 4.9%. If the standard variable rate rose to 7.9%, your discount still be 2%. Therefore, your pay rate would be 5.9%.
- The lender discounted rate benefits mortgagees with a genuine discount from the lender’s standard variable rate.
- If rates are decreasing, then discounted rates become more attractive.
- Uncertainty – if rates rise, so will yours.
- Lenders will generally lock you into the discounted rate. So, if rates are increasing, you could end up with increased monthly payments above what you expected.
Each scheme type has pros and cons, which we can investigate further at the appropriate time. The benefits of each are generally dependent on market conditions and personal attitudes to risk.
For further information, please call 03300949409 or email mymortgage@mmpe.co.uk
