What are variable rate mortgages?
Variable rate mortgages are either based on the lender’s standard variable rate (SVR) which is an interest rate set by the lender but dependent upon the Bank of England’s base rate or they can be directly linked to the base rate, in which case they are called tracker mortgages. As a rule of thumb, a lender generally sets their SVR around 2-3 per cent above the base rate.
How do variable rate mortgages work?
The interest you get charged on variable rate mortgages can fluctuate depending on what happens to your lender’s SVR or the Bank of England base rate. Your payments will go up when these rates rise and go down when they fall.
If you have a mortgage which is linked to the lender’s standard variable rate then you must be aware that your payments will not be entirely dependent on changes made by the Bank of England to the base rate. Tracker mortgages will generally follow these shifts, in that if the Bank of England cuts the base rate by 0.25 per cent then your mortgage interest payments should also fall by 0.25 per cent. If you have a standard variable rate mortgage though you could, however, find that your mortgage lender has not passed the interest rate cut on in full so your interest payments might only fall by say 0.2 per cent.
What are the different types of variable rate mortgages?
- Standard variable rate mortgage: All lenders have a SVR. They are generally in line with the base rate – set 2-3 per cent above it – but do not have to change at the same time or by the same amount as the base rate.
- Discounted variable rate mortgage: This is linked to the lender’s SVR but will come with a discount for a set period of time. For example, you could have discount of 1 per cent off the SVR for a set term (usually between 6 months and 3 years). When the discounted period ends the interest rate on your loan would then just revert to the SVR.
- Base rate tracker mortgage: Commonly called a tracker mortgage. As the name suggests, any changes made to the Bank of England base rate will be mirrored by this mortgage. Your lender will generally charge a fixed percentage above the base although, pre credit crunch, you could get deals where your interest rate was a fixed percentage below base. These types of deals have now dried up as base rates are at historical lows and indeed lot of lenders now put a floor on how low the tracker rate can fall regardless of how low the base rate falls.
- Lifetime tracker mortgage: This mortgage will track the base rate for the life of the mortgage.
What are the pros and cons of a variable rate mortgage?
Pros of variable rate mortgages:
Variable rate mortgages tend to have lower fees and no tie-in period unless you have a discounted variable rate. They can also allow more flexibility, giving you the option of making over-payments if desired so that you can pay your mortgage off earlier. There is also less of a need to remortgage when you have a variable rate. This will save you the time and effort, not to mention the expense, of having to change your mortgage every few years.
Cons of variable rate mortgages:
On the downside, as your repayments can be constantly changing, you need to allow for the possibility of a big increase in interest rates. So having excess disposable income will help.
A professional mortgage advisor you will help you determine whether variable rate mortgages are a suitable option for you and talk you through the associated pitfalls to make sure you properly assess the impact of potential rate rises on your ability to repay the loan.