The variable rate mortgage

What is a variable rate mortgage?

When you come to take out a mortgage, you’ll typically see options for fixed and variable rate mortgages as the primary categories on offer.

With a fixed mortgage, the interest rate is set for a period of time and you know exactly what you’ll pay each month for the duration of that period.

But with a variable rate mortgage, the interest rate can fluctuate during the duration of the mortgage, meaning your monthly payments could change with little warning.

Some types of variable rate mortgage typically have lower rates than a fixed mortgage, and are often seen as an attractive option for the reason. However, a Standard Variable Rate will in most cases be higher than a fixed rate.

What causes the variable mortgage rate to change?

Each lender will have its own criteria for setting their variable interest rates, but typically their variable rates are defined by The Bank of England’s interest rate, market trends, and wider factors in the UK's economy.

The rate that you pay will be decided by your lender, who will inform you when changes to the rate - and your monthly payments - are due to occur.

Some variable rate mortgages have an introductory discounted figure which acts as an incentive to the borrower when weighing up the different mortgage products on the market. However, even when the introductory discounted interest rate is factored in, borrowers will typically not be 100% certain of the exact figure that they will be charged each month.

The main types of variable rate mortgages that you should know about are:

Tracker

Tracker mortgages follow The Bank of England's centrally-set interest rate, and lenders will charge a certain percent above this rate. This means that when The Bank of England’s Monetary Policy Committee (MPC) changes the underlying interest rates across the economy, tracker mortgage interest rates rise or fall correspondingly. Tracker rates are typically lower than fixed rates. Some tracker mortgages have no Early Repayment Charges, affording you the flexibility to make larger overpayments or even repay the mortgage in full without a penalty.

Discounted rate

These give customers a period of time during which the mortgage rate is offered at a discount. For example this could be a two-year period with a lower introductory variable rate offered at a discount to the lender's Standard Variable Rate, and then reverts to the SVR at the end of the discount period.

Standard Variable Rate (SVR)

An SVR is set by each lender, and usually changes roughly in line with The Bank of England’s interest rate. An SVR usually has a higher interest rate than a discounted or fixed rate mortgage. However, SVRs tend to offer flexibility in that customers aren't locked into products and can switch to a more competitive one if and when it becomes available.

Some variable rate mortgages will have arrangement fees and other related fees. It’s always important to compare the true cost between products - taking into account fees, incentives, and monthly repayments over the initial period - for an overall comparison cost.

Advantages of variable rate mortgages

The main advantage of a variable rate mortgage is that you benefit from interest rates decreasing - if interest rates decrease, then your monthly repayment would decrease accordingly.

Most variable rate mortgages also offer the ability to overpay on your mortgage, which means that you can pay it off early and pay less interest on the overall mortgage loan. Some tracker rate mortgages may require you to pay an Early Repayment Charge, however.

Disadvantages of variable rate mortgages

The flip side of interest rates applies; if the underlying interest rate (or the tracker that the lender uses to set its variable rate mortgages) increases, then your monthly repayments will increase too.

There’s no guarantee of a set repayment each month and this could change repeatedly over the term of your mortgage. This leads to uncertainty of payment which some customers will prefer to avoid.

Types of variable rate mortgages

Tracker mortgages

With a tracker mortgage, the variable interest rate moves along with the underlying movements of The Bank of England base rate.

This is currently 0.75% (as of August 2018), and was until fairly recently at a historic low of 0.25% for over a decade. In the past, it’s been as high as 17%.

Bear in mind that the mortgage tracker rate on your product will typically be set at 1-2 percentage points above the underlying tracker to allow a margin of profit for the lender.

Additionally, your tracker mortgage could include a minimum interest rate, or 'collar', below which the interest rate will never fall. Again, this preserves margins for the lender.

Standard Variable Rate (SVR) mortgages

Every mortgage lender will have its own Standard Variable Rate, or SVR. This will change whenever the lender chooses to change it.

Usually, the SVR is linked to a market indicator, such as The Bank of England’s interest rate, but this isn't always the case and rates can vary widely between lenders and change freely. They tend not to be competitive compared to the rest of the market.

When you take out a new mortgage product you may benefit from an initial special deal and then revert to the SVR when the deal ends, depending on the lender. Although the SVR is less competitive, it will generally not tie you in - meaning that you can seek out a new deal to switch for a better rate when you’re ready and pay the SVR in the meantime.

Discounted variable rate mortgages

These products are typically offered when a customer first takes out a mortgage, and the interest rate is offered at a discount versus the lender's SVR for a promotional period of time.

This could be a 1.5% discount against the SVR, with the repayment then changing as the SVR does. This fixed term could last for 2-3 years, although some products may offer a longer period of time.

Getting a variable rate mortgage with Trussle

In summary, variable rate mortgages are worth considering whether you’re a first-time buyer or remortgaging if:

  • You think interest rates will go down at some point
  • You don't mind flexibility of repayment or changing repayments
  • You want greater ability to overpay your mortgage

If you’re interested in getting a variable rate mortgage deal for any of these reasons, you may want to consider using an online mortgage broker like Trussle to look into your options. We’ll be able to search through thousands of deals from up to 90 lenders to find the most suitable deal for your needs.