The choice of whether a fixed rate, variable, discounted, capped or tracker rate mortgage is more appropriate to your needs, will take careful consideration. The article that follows provides a breakdown of the individual rates with their advantages and disadvantages as based on your attitude to risk, not all types of mortgage will be suitable.
When considering which type of mortgage product is suitable for your needs, it pays to consider your attitude to risk, as those with a cautious attitude to risk may find a fixed or capped rate more appropriate, whereas those with a more adventurous attitude to risk may find a tracker rate that fluctuates up and down more appealing.
Following is a description of the different mortgage rate options along with a summary of the main advantages and disadvantages for each option.
Fixed Rate Mortgages
With a fixed rate mortgage you can lock into a fixed repayment cost that will not fluctuate up or down with movements in the Bank of England base rate, or the lenders Standard Variable Rate. The most popular fixed rate mortgages are 2, 3 and 5 year fixed rates, but fixed rates of between 10 years and 30 years are now more common at reasonable rates. As a general rule of thumb, the longer the fixed rate period the higher the interest rate. Similarly lower fixed rates are applicable when the loan to value falls below 75% whereas mortgages arranged for 85% or 90% of the property value will incur a much higher mortgage rate.
Having the peace of mind that your mortgage payment will not rise with increases in the base rate. This makes budgeting easier for the fixed rate period selected, and can be advantageous to first time buyers or those stretching themselves to the maximum affordable payment.
The monthly repayment will remain the same even when the economic environment sees the Bank of England and lenders reducing their base rates. In these circumstances where the fixed rate ends up costing more, remembering why the initial decision was made to select a fixed rate, can be helpful.
Discount Rate Mortgages
With a discount rate mortgage, you are offered a percentage off of the lenders Standard Variable Rate (SVR). This takes the form of a reduction in the normal variable interest rate by say, 1.5% for a year or two. Assuming that the higher the level of discount offered the better the deal is a common mistake of those considering a discount rate. The key bit of information missing however, is what the lenders SVR is, as this will dictate the actual pay rate after the discount is applied.
As with a fixed rate, the longer the discount rate period the smaller the discount offered, and the higher the rate. Shorter periods such as 2 years will attract the highest levels of discount. In addition when considering the amount to be borrowed, the increased risk to the lender of providing a 90% loan will be reflected in the pay rate, with lower borrowing amounts attracting more competitive rates.
Should the lender reduce their standard variable rate your interest rate and monthly payment will also reduce.
When the lender or Bank of England increases their base rate, your mortgage payment will also increase. However in some circumstances lenders do not always pass on the full amount of a Bank of England base rate reduction.
Affordability of the mortgage at the end of the discount rate period should be considered at outset. There are no guarantees that follow on rates will be available, and so you should make certain that you are able to afford the monthly payment at the lenders standard variable applicable upon expiry of the discount rate period. Allowing for an increase in interest rates above the SVR would be prudent to avoid a ‘Payment shock’.
Tracker Rate Mortgages
Tracker rate mortgages guarantee to follow the Bank of England base rate when it moves up or down. Tracker rates are expressed as a percentage above or below the Bank of England base rate such at +0.5% over BOE base rate for 2 years.
The most popular tracker rate mortgages have been 2 and 3 year products, but there is now an increasing demand for lifetime tracker rates as borrowers are starting to realise that the Bank of England base rate has been reasonable competitive, and having a mortgage product linked to it could be beneficial in the long term.
A tracker rate guarantees to follow the Bank of England base rate for however long the tracker rate is set up for. This means a tracker rate mortgage payment reduces in line with reductions to the base rate by the Bank of England.
The overall cost calculation of a Lifetime tracker rate can be significantly lower than taking shorter term mortgage products with the ongoing costs of remortgaging such as valuation fees, legal fee and lender arrangement fees. Lifetime tracker rates often have no early repayment penalty restrictions.
The mortgage payment will go up if the Bank of England increases the base rate. As with most other types of mortgage, early redemption penalties will apply for some or all of the tracker rate period and are typically 5% of the loan or six months interest.
Variable Rate Mortgages
Variable rate mortgages are more commonly known as the lenders Standard Variable Rate (SVR), and are the rate that you come onto after the expiry of a fixed, discounted, tracker or capped rate mortgage. A variable rate is similar to a tracker rate in as much as the lender will base their SVR on the Bank of England base rate plus a loading of between say 2.5% and 3.5%. That is where the similarity ends however.
The main advantage of being on the lenders Standard Variable Rate (SVR) is that there will be no early repayment charge for redeeming the loan in full. When there is uncertainty about rate movements in the financial markets, this can provide a degree of certainty and flexibility. For those wishing to fix their mortgage rate, an SVR with no early repayment charge can provide the breathing space required to just wait and see before committing.
Historically not all lenders have chosen to pass on through their standard variable rates, reductions made by the Bank of England. This situation is changing and those with SVR mortgages benefit from a reduced payment.
Generally the SVR will be a higher rate of interest and so your mortgage payment will be greater than if you were on a tracker rate, fixed rate or discounted rate mortgage product. Additionally and in comparison to other types of mortgage, a higher monthly payment can result when lenders do not pass on any or all of a reduction in the Bank of England base rate which has not been uncommon in the past.
Capped Rate Mortgages
The capped rate is a variable rate mortgage which has a fixed limit to how far the interest rate can increase (the cap), and provides the option to know the maximum level of mortgage payment from outset. For those who are risk adverse, but who wish to have the certainty of payment as well as benefit from interest rate reductions, the Capped rate mortgage offers the best of both worlds. For example if the cap is set at 6% and the banks rates go below this rate, then your repayments will go down to reflect the reduction, with the guarantee that should rates go above the 6%, your payments will remain based on the maximum 6% because of the cap.
If the Bank of England base rate falls resulting in a fall in the lenders standard variable rate below the level of the capped rate, then your monthly repayment will reduce. For many this provides the peace of mind and certainty for ease of budgeting offered by a know maximum monthly payment.
Because a capped rate offers the best of both worlds to the borrower, the capped rate is usually uncompetitive as lenders need to price in the risk of rate reductions, leaving those such as first time buyers or those stretching their affordability, exposed to a higher rate than would be available with a fixed rate. This means that competitive capped rates are seldom available with UK lenders who prefer to offer fixed rates instead.
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