Mortgage Guides

Capped tracker and ‘drop lock’ mortgages - the perfect compromise?

By Martin Fagan - news@consumerchoices.co.uk

Torn between a fixed-rate mortgage and a tracker? A capped tracker or mortgage with a ‘drop lock’ option could offer the ideal solution…

At the moment, the choice of whether to get a tracker mortgage or a fixed-rate mortgage is a difficult one.

Do you opt for the more expensive fixed-rate mortgage and pay a premium to set your monthly repayments and protect yourself from future rate increases?

Or should you take advantage of a cheap tracker, but risk rate increases that could see your monthly repayments jump by hundreds of pounds?

There is no easy answer to this question, but there are alternative products that promise the best of both worlds…

• What are capped tracker mortgages?
• What are tracker mortgages with a droplock option?
• Do these products offer the perfect compromise?

What are capped tracker mortgages?

A capped tracker mortgage basically tracks the base rate but won’t rise above a set level.

These mortgages offer an alternative solution for people who want to take advantage of the current historically low base rate, but don’t want to risk their mortgage rate rising too high.

This type of mortgage made a comeback when First Direct launched a capped tracker which tracks the Bank of England base rate plus 2.18%, but capped at 3.98% (currently 2.68%) for the life of the loan (three years) until 30 September 2014.

The mortgage has a maximum loan-to-value (LTV) of 65% and comes with a booking fee of £999 for every £400,000 of borrowing (or part thereof) - a cost that definitely needs taking into account when working out whether this mortgage offers the best value for your circumstances.

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What are tracker mortgages with a droplock option?

A tracker mortgage with a “drop lock” option (also known as “switch ‘n’ fix” or “track ‘n’ fix) is basically a tracker mortgage with a provider that allows you to switch to a fixed-rate whenever you wish, without penalties.

This type of mortgage allows you to take advantage of a low base rate, but gives you the chance to fix your interest rate if it looks like rates are on the rise.

Even though economists and housing market analysts believe Bank of England base rates will stay at 0.5% for the remainder of 2011, many people are seeking to benefit from this historically low base rate with the added safety net of being able to fix their mortgage in the event of an unexpected rate rise.

Mortgage brokers and independent financial advisers (IFAs) are reporting an increased demand for these types of mortgage and a number of lenders have responded by launching drop lock products. Lenders including Nationwide, Royal Bank of Scotland, Santander, Skipton, Woolwich, and the Yorkshire Building Society now offer such deals.

Royal Bank of Scotland is offering a 2.59% variable rate until 31 August 2013 with a maximum loanLTV of 60% with a £999 arrangement fee. The Santander drop lock deal is at a variable rate of 2.19 per cent for two years on remortgages only, up to a maximum 60% LTV with a £1,495 fee.

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Do these products offer the perfect compromise?

These mortgages do offer the right compromise for people who want to benefit from low tracker rates but don’t want to take on high risk. However, they are far from perfect.

Not only does the capped tracker from First Direct come with a hefty arrangement fee, the cap of 3.98% (until 2014) can easily be beaten by other fixed-rates available at the moment.

However, if rates stay low, your interest rate may never reach this cap and at least you have the security of knowing your rate won’t rise too dramatically over the next three years.

However, that peace of mind will have cost you not only by having to pay a higher interest rate than with a conventional fixed-rate mortgage, but also in hefty arrangement fees.

And there are other pitfalls, chief of which is that fixed rates on mortgages always anticipate a base rate rise and so increase before the Bank of England actually puts rates up. This means by the time you realise you need to fix, the best deals offering the lowest rates will have long gone.

Also, the deal on the table won't necessarily be the best on the market but, by then, you’re tied to that lender and have little choice but to go with the rate on offer.

While these alternative mortgages do offer significant benefits, whether they are best for your circumstances depends on several factors, including the size of your mortgage in relation to the value of your property, your current outgoings, your attitude to risk and where you think the base rate is heading.

If you are thinking about taking out a capped or drop lock tracker, we strongly recommend that you contact an IFA or mortgage broker, who can provide you with tailored advice to suit your situation.

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