What is a variable rate mortgage?

How variable rates differ from fixed rates

When you take out a mortgage, you’ll 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.

Variable rates can be cheaper than fixed

That’s not to mean a variable rate is necessarily a bad option, as variable products can be cheaper than equivalent fixed rates (initially at least), especially if rates drop. 

Indeed, in July 2019 typical 2-year trackers stood at 2.01% compared to 2.49% for 2-year fixed rates. (1)

Most variable products have a ‘discounted’ or low-rate period for a set duration of time, after which you can take out a new product, like with a fixed rate mortgage.

One variable rate to be wary of is a Standard Variable Rate (SVR). This is a typically higher rate lenders use when a fixed rate, tracker, or discount detail expires. 

However, for some it can be cheaper to hold onto this rate than to change, as there is no Early Repayment Charge. If unsure in this case, it’s always best to look into your options before you’re transferred to and SVR rate.

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Types of variable rate mortgages

Tracker mortgages

With a tracker mortgage, the interest charged by your lender will be the Bank of England base rate plus or minus a certain percentage. 

The Bank base rate is currently 0.75%, where it has been since August 2018.(2) 

Products usually span for two or five years, though you can also get three year, 10-year, and ‘lifetime trackers’, which will track the base rate for the lifetime of the mortgage.

Your tracker mortgage could include a minimum interest rate, or 'collar', below which the interest rate will never fall, so the lender will always make some profit. Some lenders will also have a ‘cap’ to restrict the maximum rate.

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. More tracker deals have this option, but some fixed deals also allow for this.

Discounted variable rate mortgages

These products are similar to tracker mortgages, except they are discounted against the lender’s Standard Variable Rate, or SVR.

This means you are at the mercy of your lender should they choose to raise their SVR, which they can do at any time.

Generally however, lenders change the SVR in line with whether the Bank of England base rate rises or falls.

You typically lock onto discount mortgage rates for a fixed term, lasting two, three or five years.

Standard Variable Rate (SVR) mortgages

Every lender has its own Standard Variable Rate, which is generally uncompetitive – averaging at 4.89% – but you are free to switch to another deal without incurring any charges. (1)

Customers generally roll onto an SVR after their fixed rate, tracker or discount period expires.

However, there are exceptions. 

Since 23 January 2018 Santander customers have rolled onto a ‘Follow-on Rate’, which is more competitive than its SVR. (4)

Advantages of variable rate mortgages

The advantage of a variable rate mortgage is that you can take advantage of some of the lowest rate deals on the market, if you are willing to risk having some uncertainty regarding your future rate.

Given that the base rate stayed at 0.5% from 2009 to 2015, before falling to 0.25% in 2016, those who took out a tracker or discount mortgage over the period likely paid less than those chose a fixed rate, which generally has a higher rate the longer you fix for.

If the base rate falls, of course, your mortgage rate will also fall.

Disadvantages of variable rate mortgages

It goes both ways. If the Bank rate or SVR rises then your monthly repayments will increase too.

Therefore you’ve got no certainty that your mortgage will be the same price over the term.

Some tracker rate mortgages may also require you to pay an Early Repayment Charge.

Predicting the Bank of England base rate

When choosing whether to get a variable or fixed rate, much depends on what you think will happen with the financial markets and the Bank of England base rate.

If you think the rate is likely to be hiked sooner, a fixed rate is probably a better option. 

However if you think the Bank of England is likely to keep them at 0.75%, or lower them even further, a variable rate might make sense.

When making your decision therefore it’s a bit of a gamble – will a fixed rate or a variable rate pay off in the long term? 

Regardless of what you decide, there are competitive products in both categories.

Brexit

In the current environment, with Brexit uncertainty on the agenda, some borrowers are reportedly being cautious by seeking longer-term fixes. (5)

People may consider fixed rate mortgages to be a better option, as there won’t be any uncertainty regarding their mortgage payments, regardless of what happens to the economy.

However, given that the Bank of England tends to keep the base rate lower for longer in times of economic uncertainty, there’s an argument to be made that it could sit at rock bottom levels for a while, given that the road ahead for Brexit is unclear.

Based on that argument, a variable could make more sense.

Keep in mind that choosing between a fixed and a variable is a personal decision and dependent on your personal circumstances, so it’s difficult to conclusively say which is the better option.

What to be aware of when coming to the end of your initial term

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'd prefer to have a look at other deals.

If you use Trussle to find a mortgage, we’ll look at both variable and fixed rate options to recommend a deal according to what we think would best suit your needs.

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