Fixed, Tracker, And Variable Rates Explained
13th April 2017
With a fixed rate mortgage, the interest rate stays the same for an agreed period (two years, for example) while the rate of a variable mortgage can move up and down. A tracker mortgage is a type of variable rate mortgage that follows another rate, such as the base rate set by the Bank of England.
When you take out a mortgage you have several choices to make, and one of the most important is how the interest rate will be set. Although you’ll come across lots of different wording, the main choice is between a mortgage with a fixed rate and a mortgage with a variable rate.
Whilst a variable rate may look particularly attractive while interest rates are low, a fixed rate mortgage means predictable repayments and protection from shifts in the market. Each has its pros and cons and what’s right for you will depend on your individual circumstances.
This guide explains fixed rate and variable rate mortgages (including trackers and SVRs), and considers some of the advantages and disadvantages of each:
Fixed rate mortgage
As you’d expect, a fixed rate mortgage gives you a fixed interest rate for an agreed period. No matter what happens to market rates during this time, you’ll keep paying back your loan at your set rate.
One of the main advantages of a fixed rate mortgage is that your repayments are predictable, and even if borrowing becomes much more expensive, your mortgage interest rate won’t increase. Of course one of the disadvantages of a fixed rate mortgage is that it won’t go down either, even if UK interest rates drop.
Rates are generally fixed for a period of between two and five years, although some lenders offer fixed rates for as long as 10 years. You may have to pay a steep fee if you leave the deal before the initial period has ended, so take this into account when you’re deciding how long to fix your deal for.
Variable rate mortgage
If you have a mortgage with a variable rate, the interest rate can move up and down, so your repayment amount is likely to change over time. The interest rate will usually be impacted by movements in the UK economy and trends in the lending market.
The main advantage of a variable rate is that it may be quite low during times of low interest rates, but the flipside is that your rate will usually increase if market rates increase. Unlike a fixed rate deal, you don’t have the reassurance of set repayments.
There are three main types of variable rates that you’re likely to come across: tracker rates, discounted rates and Standard Variable Rates (SVR).
A tracker rate mortgage is a type of variable rate mortgage that moves according to a particular economic indicator. This is usually the Bank of England’s base rate. At the time of writing (April 2017) the base rate is just 0.25%, but in the past it has been as high as 17%.
It’s important to understand that the tracker rate will usually be set at one or more percentage points above the rate that it’s tracking. Your deal may also include a ‘collar rate’, which is a minimum rate set by the lender.
Standard Variable Rate (SVR)
Each mortgage lender sets their own Standard Variable Rate (SVR), which they can change when they choose. Lenders usually base their SVRs on certain market indicators, but the rates vary a lot from lender to lender, and they can change at any time. Compared to other mortgage rates, SVRs are often not very competitive.
When you first take out your mortgage, you’re usually offered a special deal for a limited period of time. When this initial deal is over, you’ll generally be switched onto the lender’s SVR. As this point, you may decide to remortgage to benefit from another initial deal. Switching from a lender’s SVR of 4.63% to an initial rate of 1.39%, for example, could save you £3,500 per year, based on a mortgage of £173,400 repayable over 25 years.
Discounted variable rate
Discounted variable rates are usually offered for an initial period when you first take out your mortgage, and they’re based on the lender’s SVR. For example, you may be offered a discount of 2% on the SVR, so you’ll pay a rate that’s 2% below the lender’s standard rate, which is likely to move up and down.
In general, you’ll get this discounted rate for a fixed period (two or three years, for example), and after this you’ll be switched onto the lender’s SVR.
Choosing between a fixed rate, variable, or tracker mortgage
It’s very difficult to predict which type of mortgage will be cheaper over time, as this depends on your individual circumstances and the deals you’re offered as well as the broader financial environment.
If you expect interest rates to go up in the near future, a fixed rate mortgage may be more appealing, while a variable rate mortgage may look like a better option if you expect rates to stay low or fall. However, it’s impossible to know exactly how the markets will move in the future.
You should also consider whether you’d be able to afford to make your repayments if interest rates increased. If you’d struggle to cover your mortgage payments if your rate went up, a fixed rate may be more sensible.
Also remember that whichever mortgage type you choose, you’ll probably end up paying the lender’s SVR once your initial term is over. If you’ve signed up to Trussle, we’ll let you know when it makes sense to think about switching so that you avoid paying the SVR.
If you use Trussle to find a mortgage, you can tell us whether you have a strong preference for a fixed rate or a variable rate mortgage. If you don’t, we’ll look at both fixed and variable deals when we’re searching for your mortgage and recommend the deal that we think makes most sense for you.