Mortgage Guides

Variable-rate mortgages

Updated: Friday 25 November, 2011

By Martin Fagan

This guide will explain everything you need to know about variable rate mortgages - how they work, their advantages and disadvantages, and what sort of borrower they may suit.

If you are looking to buy a house, then you’ll have to decide what type of mortgage is going to best suit your needs. A large group of mortgage products are known as variable rate mortgages. They include tracker mortgages, discount mortgages and capped mortgages.

This guide will explain everything you need to know about variable rate mortgages, how they work and the advantages and disadvantages of these types of mortgage, as well as the fundamental differences between variable and fixed-rate mortgages.

• What is a variable-rate mortgage?
• Variable-rate mortgage or fixed-rate mortgage?
• Types of variable-rate mortgage
• The advantages of a variable-rate mortgage
• The disadvantages of a variable-rate mortgage
• What sort of borrower would benefit from a variable rate mortgage?
• Our recommendations

What is a variable-rate mortgage?

Put simply, a variable rate mortgage is a mortgage whose interest rate rises and falls with the base rate set by the Bank of England’s Monetary Policy Committee (MPC) or to another variable rate, such as the lender’s standard variable rate (SVR).

If your rate is tied to the base rate, this means that if the base rate falls, your mortgage interest rate will also fall, and therefore your monthly repayments will fall.

However, if the base rate rises, then your mortgage interest rate will also rise and your monthly mortgage repayments will go up. Depending on the size of your mortgage and the amount by which the interest rate falls or rises, the difference in your monthly repayments can be quite dramatic.

Back to the top

Variable-rate mortgage or fixed-rate mortgage?

When you take out a mortgage you have the choice of either a fixed-rate mortgage or a variable rate mortgage.

Your financial situation and budget will help you to determine which of these mortgages is the best option for you. You should speak to an independent mortgage broker to get impartial advice and information. It's also a good idea to research previous base rate levels, and consider if the base rate is predicted to fall or rise, as this may also impact upon your decision.

Read our guide on choosing a fixed or tracker mortgage and sign-up to our money news RSS feed to make sure you stay on top of changes in the Bank of England base rate.

Back to the top

Types of variable rate mortgage

The following are all different types of variable rate mortgages.

1. Standard variable rate (SVR) - An SVR is the standard interest rate that a lender charges its customers if they are not taking one of their other deals. It is the standard interest rate you automatically default to when any deal period you may have ends. The standard variable rate is set by the lender, and in the past has moved largely in line with cuts and increases in the base rate. However lenders do not have to pass on changes. A number of lenders have refused to pass on rate cuts to their SVRs. This means that, although the base rate has fallen massively, certain lenders’ SVRs have not.
2. Tracker - Tracker products follow the base rate at a margin above, for example the base rate plus 2%. Tracker mortgages are available over different terms. After the term is over you will be usually be switched to the lender’s SVR, but are usually free to remortgage without incurring any penalties. Due to the credit crunch, banks are charging a larger premium to borrow at the moment, so the trackers being offered have bigger margins over the base rate than in previous years.
3. Lifetime trackers - Lifetime trackers are just like ordinary tracker mortgages, except the margin above the base rate will be the same until the mortgage is repaid. These are good if you don’t want to have to remortgage every few years, and also tend to be quite flexible, so you can switch mortgages easily without being penalised.
4. Discount - A discount mortgage is slightly different, and is tied to the lenders’ SVR rather than the Bank of England base rate. They tend to track the lenders SVR at a discount of between 1% and 2%. The discounted rate normally applies for a set term, during which time you’ll be locked in and charged a fee if you want to redeem your mortgage. After the term is over, you will be usually be switched to the lenders SVR but are generally free to remortgage with another lender.

Back to the top

The advantages of a variable-rate mortgage

If the Bank of England base rate falls, your monthly payments will automatically drop if you have a tracker mortgage and may drop if you have a discount mortgage or are on your lender's SVR. Some lenders may put a “collar” on how low payments can go though, so check when applying for your mortgage.

If you have a lifetime tracker mortgage you can usually switch to another mortgage type (e.g. fixed-rate) without being charged redemption penalties

At the time you take one out, the interest on variable rate mortgages is usually lower than the lender’s fixed-rate equivalent, so you should start off paying less.

Back to the top

The disadvantages of a variable-rate mortgage

If the Bank of England base rate goes up, your monthly repayments are likely to go up too. Some deals have a “cap” on how high payments can go though, so check when applying for your mortgage.

If interest rates fall, lenders will pass on the cuts to those on tracker and discounted mortgages, but not necessarily to those on the borrower’s SVR.

With a variable rate mortgage it can be more difficult to budget in the long-term because your payments will change over time.

Back to the top

What sort of borrower would benefit from a variable rate mortgage?

A variable rate mortgage is a good option for borrowers who feel they can afford to take the risk of repayments fluctuating.

If you don’t need to budget your mortgage payments, or want to gamble on interest rates staying low, then this type of mortgage will suit you.

Anyone thinking of taking out a variable rate mortgage needs to consider whether they will be able to keep up with repayments in the event of an interest rate rise, as this could really push up their monthly costs.

For example, if your mortgage is £150,000 at 5% and the rate goes up to 6.25%, then your monthly repayment would increase to £989.50 from £876.89, an increase of £112.61 a month or £1,351.32 a year.

Back to the top

Our recommendations

In the current economic climate, with the cost of living and inflation rates on the rise, many people will prefer the security of a fixed-rate mortgage. If you don’t want to run the risk of being hit with rising interest rates you should probably choose this mortgage.

However, if you think you can cope financially with any potential rises in costs then a variable rate mortgage could be a suitable option.

Use our mortgage calculator to see how much your repayments will be with a fixed or a variable rate mortgage.

If you’re considering a variable rate mortgage then you should compare mortgage deals consult a “whole of market” mortgage broker to ensure you get the best deal.

Back to the top

THINK CAREFULLY BEFORE SECURING ANY DEBTS AGAINST YOUR HOME.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON A MORTGAGE OR ANY OTHER DEBT SECURED ON IT.