Mortgage Guides

Tracker mortgage or fixed-rate mortgage – Which should you choose?

Tuesday, 14 July 2009

Writes Hazel Cottrell hazel@consumerchoices.co.uk

How do you decide whether to get a fixed-rate or tracker mortgage, and is there a good compromise?

When it comes to mortgages, this is the question on everyone’s lips – and it’s a tough one. Should you pay a premium to fix your mortgage and have the certainty of set payments or should you go for a cheaper tracker and hope the base rate stays low?

There is no easy answer to this question, as much depends on your own personal circumstances, your attitude to risk and what you think will happen to rates in the future.

However, there are plenty of things to think about when making your decision, and in this guide we will explore these issues, as well as looking at alternative products that allow you to track the base rate without risking sky high rate increases.

• What are the pros and cons of fixed-rate mortgages?
• What are the pros and cons of tracker mortgages?
• What to consider when making your decision
• Capped tracker and droplock mortgages – the perfect compromise?

What are the pros and cons of fixed-rate mortgages?

The main advantage of a fixed-rate mortgage is that it protects you from future rate increases for a set period of time. It also allows you to budget more effectively as your repayments will be the same each month.

However, fixed-rate mortgages are currently significantly more expensive than trackers that are linked to the Bank of England base rate.

Indeed, at the time of writing, fixed-rate mortgages have just rapidly increased in price. Many people were choosing to fix while rates were relatively low, but this was not ideal for lenders as they need to keep a balance between customers on fixed and tracker rates to mitigate the risk of their own wholesale costs rising.

As Ray Boulger, mortgage expert at John Charcol (www.charcol.co.uk) explained, fixed-rates have risen “as lenders respond to increased demand by pushing up rates even more to deter business.”

So, fixed-rate mortgages are more expensive, but less risky.

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What are the pros and cons of tracker mortgages?

The main advantage of tracker mortgages is that they are currently much cheaper than fixed-rate mortgages. And, for as long as the base rate remains the same, your tracker repayments will remain low.

However, no-one knows how long the base rate will continue at its current historic low of 0.5%. It could stay low for years, or it could be increased next month and by taking out a tracker mortgage you are taking a chance and predicting that the base rate will not rise too high.

If the base rate increases dramatically, so will your tracker rate and your monthly repayments. Depending on the size of your mortgage, this could mean you have to find hundreds of pounds extra each month to pay your mortgage.

So, tracker mortgages are cheaper, but more risky.

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What to consider when making your decision

Choosing a mortgage is a big decision, and it is recommended you consult an independent financial adviser (IFA) or independent mortgage broker who can assess your personal circumstances before making any decision.

However, there are several things that everyone should take into account when choosing between a fixed-rate and tracker mortgage:

1. Your view on the base rate

If you are choosing between a fixed-rate mortgage and a tracker mortgage, then you need to take a stance on where you think the Bank of England base rate is heading.

Ray Boulger recently said that as early signs of recovery in the economy are now looking less certain, “the likelihood of the base rate remaining low for longer is increasing.”

However, no-one really knows what the future holds and when exactly the base rate will rise again. When making your prediction, you should take into account the views of mortgage experts and your IFA.

If you think the base rate will stay low for a long period of time, you might choose a tracker mortgage and hope to benefit from the long period of low rates.

However, if you think rates are set to rise fairly soon and by a reasonable amount, you are more likely to choose a fixed-rate mortgage to protect yourself.

2. The size of your mortgage

The size of your existing mortgage is an important factor to consider when deciding between the two types of mortgage, as it is likely to affect your attitude to risk.

The bigger your mortgage, the more risk you would be taking on, by choosing a tracker mortgage.

For example, if you have a £150,000 mortgage, and are paying it over 25 years, a rate increase from 4% to 8% would see your monthly repayments jump by £370 - from £800 to £1170.

However, if you just have £20,000 left to pay on your mortgage, over 5 years, the same rate increase would cause a less dramatic monthly increase of £43 – from £374 to £417.

Crucially, when contemplating a tracker mortgage, you need to work out what your monthly repayments would be if the base rate did rise by 2%, or 4%, or even 10% and how you would cope with this.

3. Your outgoings

Linked to the point above, when deciding between a fixed-rate mortgage and a tracker mortgage, you need to look at your own finances and what proportion of your outgoings are taken up by mortgage repayments.

If a large proportion of your budget is already taken up with your mortgage repayments, you might choose a fixed-rate to ensure that your repayments don’t increase further.

However, if your mortgage repayments only take a small proportion of your budget and you have plenty of disposable income that you could use to meet increased repayments if rates did increase, you may be more likely to consider taking the risk with a tracker.

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Capped tracker and droplock mortgages – the perfect compromise?

If you are struggling to choose between a fixed-rate and a tracker, you should take a look at capped tracker mortgages (which track the base rate but won’t rise above a set level) or a tracker mortgage with a droplock option (which allows you to switch to a fixed-rate deal when you wish).

For some people these mortgages offer the best of both worlds – you can track the low base rate without the risk of your rate increasing too high. However, these mortgages often come with fairly large arrangement fees and there are other issues to consider too.

For more information, see our guide to capped tracker and droplock mortgages.

To get the best mortgage deal for your circumstances, we recommend that you discuss your options with an independent financial adviser or mortgage broker.

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