Money News Feature

Mortgages: Lifetime tracker or long-term fix?

Updated: Thursday 28 April, 2011

By Martin Fagan news@consumerchoices.co.uk

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What’s the best mortgage deal to have for the coming years – a fixed-rate or a tracker?

Though the Bank of England’s Monetary Policy Committee (MPC) holding interest rates at an all-time historic low of 0.5%, many experts are predicting a rate rise in 2011 and this prospect is making mortgage holders a bit twitchy.

Many mortgage holders are agonising over whether or not to fix their mortgage before rates go up, or else track the interest rate upwards in the hope it won’t go much further because the thought of being locked into a fixed-rate deal scares them.

With rates at an historic all-time low it’s highly unlikely the Bank of England will lower them. So it’s a one-way bet: rates will go up, we just don’t know when.

Fixed-rate mortgages

Locking into a fixed-rate deal now could mean that, potentially, when rates do rise you’ll save thousands of pounds in interest. But long-term certainty comes at a price, in the shape of a higher rate of interest on your loan.

The peace of mind offered by a fixed-rate mortgage will cost you more

The security and peace of mind offered by a fixed-rate mortgage will cost you more than the equivalent tracker mortgage, but that extra payment on the fixed-rate is the premium you pay for effectively insuring yourself against future rises in interest rates for the deal’s duration.

The large boost in remortgage activity since January 2011 has been powered by consumers taking out fixed-rate deals. Mortgage broker John Charcol said the first two months of 2011 saw a sharp increase in the popularity of fixed rates, where 56% of mortgages the broker arranged were fixed-rate.

According to Countrywide, the UK’s largest Property Services Group, in the first quarter of 2011, 87% of mortgage applications were for fixed-rate mortgages, a 26% increase year-on-year.

Since lenders are also predicting a base rate rise before the end of the year, fixed-rate deals are becoming more expensive. In April 2010, the average rate for a two-year fixed-rate mortgage was 2.99%, but in April 2011 it was 4.58% - an increase of 54%.

The longer you want to fix for, the more expensive it gets. The average five year fixed-rate is 4.9% and if you want peace of mind for 10 years, this currently costs 5.5%, a full five percentage points over the Bank of England’s historically low base rate of 0.5%.

So, is it worth taking the risk - and expense - of fixing now to insure against future rate rises? The inflation figures announced in April saw an unexpected fall and many mortgage analysts now predict the Bank of England base rate is likely to remain unchanged for the remainder of the year.

Also, experts at John Charcol say you would have to be convinced the Bank of England base rate is likely to rise by a full 3% - that’s 12 separate rises of 0.25% or six separate rises of 0.5% - before fixing your rate made financial sense. In the current uncertain economic climate, the broker favours tracker mortgages, in particular lifetime trackers, because their rates are very similar to two or three-year trackers, have similar early repayment charges, but only involve a one-off arrangement fee.

When not to fix your mortgage

The thought of locking yourself into a fixed-rate deal may seem quite daunting though. And fixing at the wrong time - and for the wrong duration - can be a costly misjudgement.

Let’s imagine it’s April 2006, five years ago. The base rate is at a comfortable 4.5% and everything you read or hear about interest rates says it will rise in the coming months, so you decide to fix for two years, until April 2008. In that time, interest rates rise to a peak of 5.75% (July-Nov. 2007) and when your deal runs out they are at 5%. Fixing for two years saved you a lot of money, even though you finished the deal with the base rate 0.5% higher than you started.

But what would have happened if you’d fixed for that extra year? From the base rate of 5% in April 2008, it fell to 4.5% in October 2008 (your original fix level) and, by April 2009, it was a meagre 0.5%. Even though you were locked into a fixed-rate deal while rates were falling for the last six months, you probably came out ahead financially. Had you fixed for five years though, for the final two years, interest rates were at 0.5% - a full 4% lower than when you fixed.

This would have cost you dear: either you gritted your teeth and paid the full rate until the fixed period ended or else paid punitive early redemption fees to your lender to remortgage to a cheaper deal.

Lifetime tracker mortgages

Lifetime tracker mortgages do what they say on the tin: they track the Bank of England’s base rate up or down for as long as you hold the mortgage, rather than for a set period of time, and then reverting back to the lender’s standard variable rate (SVR).

The main difference with a tracker mortgage over a lender’s SVR mortgage is that a tracker mortgage tracks the Bank of England’s base rate and will fluctuate based on the increase or decrease of the Bank’s base rate. This will work out as a better deal than a lender’s SRV mortgage as lenders tend to inflate their SVR by more than the Bank of England’s rises, and generally fail to pass on the full amount when rates are cut.

Also, the difference between a tracker mortgage and a discount mortgage is that discount rates are discounts on the lender’s SRV and not the Bank of England’s base rate.

The rates quoted on lifetime trackers tend to be “Bank of England base rate plus a specified percentage”, with that percentage remaining constant throughout the life of the loan. For instance, if the rate being offered is base rate (currently 0.5%) plus 2.69%, then the rate will be 3.19%. If the base rate doubles to 1%, then your rate will rise to 3.69%, so the only factor that can alter your mortgage rate is the Bank of England, and not your lender.

The lower your loan-to-value (LTV) - the difference between the market value of your property and the mortgage secured on it - the lower the interest rate you’ll pay. On Barclays range of lifetime tracker mortgages (also available through its Woolwich subsidiary) if you have 80% LTV you’ll pay base rate plus 3.18%, but if your LTV is 70%, the rate is lower: base rate plus 2.59%. On a £150,000 loan that difference is £48.24 a month, or £578.99 a year.

And while the rates on fixed-rate mortgages have been creeping upward as the demand for them increases and lenders hedge themselves against the prospect of a Bank of England rate rise, mortgage broker John Charcol reported in April 2011 that tracker rates have stayed relatively flat, increasing the premium you pay for the security of a fixed rate.

Lifetime trackers also offer a surprising degree of flexibility. The early repayment charges (ERC) on lifetime mortgages are more benign than other mortgages. To get out of the deal within two or three years of signing up for it will cost around 1% of the outstanding balance, but after that they tend not to levy ERCs. If you find yourself with some spare cash and want to overpay your mortgage every month, you can do so without fees or penalties, although some lenders limit the amount of overpayment to 10% of the loan’s value per year for a fixed number of years (between two and four years).

If you have a lump sum and feel the most efficient use of it is to reduce your outstanding mortgage, most lifetime trackers allow unlimited lump sum payments with no penalty fees and, as the interest is calculated daily, paying off a chunk of your mortgage debt will see an immediate reduction in your monthly repayments.

HSBC’s half-way house

For really cautious souls who can’t chose between fixed-rate and lifetime tracker but wish they could have their mortgage cake and eat it, HSBC offers a Split Loan Mortgage. This unique mortgage lets you choose a two-year fixed-rate for 25%, 50% or 75% of your total borrowing requirements, with the remainder on a tracker rate. The tracker rate will go up and down at a fixed percentage above the Bank of England base rate for the duration of the loan.

The amount of the mortgage you chose to fix reflects how optimistic or pessimistic you are about the Bank of England rate rising. You need an LTV of at least 80% to qualify for the mortgage, but if you borrowed £150,000 and fixed 75% of it, the monthly payment on the fixed-rate would be £587 plus £196 on the tracker rate, making a total of £783.

If you fixed 25% of the loan, the fixed rate part would be £178 a month plus £533 for the tracker rate making a total of £711. So, the cost of insuring against a rate rise by making a greater portion of the loan fixed-rate is £71 a month or roughly 10%.

Don’t forget the fees

Also, whichever mortgage you pick, bear in mind that most come with a nasty financial sting in the tail, in the shape of an arrangement fee. The average arrangement fee for a tracker mortgage is £1,017 and the average arrangement fee for a fixed-rate mortgage is £1,054, according to research by uSwitch.com.

For most people, their mortgage is their biggest monthly financial outlay so picking the right one can mean the difference between comfortably making the payment each month and struggling. Make sure you pick the right mortgage for your circumstances and add only the bells and whistles you need - fixed rate, tracker, etc - and don’t pay for features that are of no use to you.