Mortgage Guides

Tracker mortgages – an introduction

Writes Hazel Cottrell hazel@consumerchoices.co.uk

What are tracker mortgages and is getting one a good idea? (Updated 15/9/09)

Around two in five of all existing mortgages are on tracker deals, according to an estimate from the Council of Mortgage Lenders (CML).

So what’s so great about trackers?

In this guide we look at what trackers are, their advantages and disadvantages, and whether they still offer competitive deals in the current mortgage market.

• What is a tracker mortgage?
• What are the advantages of tracker mortgages?
• What are the disadvantages of tracker mortgages?
• Common features of tracker mortgages
• Recent history of tracker mortgages
• Our recommendation

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What is a tracker mortgage?

A tracker mortgage is a mortgage with a variable interest rate that literally “tracks” the Bank of England (BoE) base rate. The rate you pay will be set at a percentage above or below the base rate.

For example, if your tracker mortgage is set at “base rate + 1%” and the base rate is at 3%, you will pay interest on your mortgage at a rate of 4%.

The government’s monetary policy committee comes together once a month to review the BoE base rate and if they decide to increase or decrease it, your interest rate will change accordingly.

Historically, it was possible to get a sub-base rate tracker, ie with an interest rate that was set at a certain percentage below the base rate. However, following the dramatic base rate cuts earlier this year, you can now only get trackers with interest rates at a percentage above the base rate.

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What are the advantages of tracker mortgages?

The main advantage of a tracker mortgage is the fact that your interest rate will automatically fall if the base rate is cut. This can have a big effect on the size of your monthly repayments.

For example, let’s imagine you have a capital repayment mortgage of £150,000 with a term of 25 years on a tracker mortgage set at “base rate + 1%”. If the base rate falls from 3% to 2%, your monthly mortgage repayments will be reduced from £800 to £717. If the base rate hit 1%, you would see your repayment fall to £640.

Indeed, the cuts in the BoE base rate earlier this year left many people who have tracker mortgages paying much less each month than they were last year. Having more disposable income has meant many of these people have been able to make overpayments and shave years off their mortgage.

Some lenders also offer a “drop-lock” option on their trackers, which allows you to switch to a fixed-rate deal whenever you choose, and usually without having to pay any charges.

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What are the disadvantages of tracker mortgages?

The main disadvantage of a tracker mortgage is the fact you are at mercy of increases in the base rate. Just as your interest rate will fall in line with reductions in the base rate, it will increase in line with hikes in the base rate. This, too, can have a big effect on your monthly mortgage repayments.

If we take the same mortgage as before as an example, if the base rate increases from 3% to 4% your monthly repayments would increase from £800 to £887, and if it hit 5% you would have to scrape together £977 a month.

For those who like to budget in advance, trackers are not ideal as your monthly repayment is unpredictable and likely to change (unlike fixed rate mortgages, where your monthly repayment is set).

Another disadvantage, which came under the spotlight recently, is the fact that some lenders apply “collars” or “floors” to their tracker mortgages. This means that the rate you pay will never fall past a set point. For example, a tracker with a collar at 3% means that your interest rate can never fall below 3%, regardless of how far the base rate falls.

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Common features of tracker mortgages

Tracker mortgages normally come with a set deal length. For example, the interest rate on a two-year tracker mortgage will track the base rate for the first two years of the term before generally reverting to the lender’s standard variable rate (SVR). Deals like this normally apply penalties if you want to switch your mortgage before the initial period has ended, in this case within the first two years.

Having said this, you can get lifetime tracker mortgages which track the base rate for the life of your mortgage. These are much less likely to apply early redemption penalties.

The application fees, valuation fees and flexibility of a tracker mortgage will depend on the lender and your own circumstances, but as with any mortgage on the market at the moment, to qualify for the best deals you will need to have a substantial amount of equity in your house or a large deposit.

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Recent history of tracker mortgages

There was a series of aggressive cuts in the BoE base rate at the end of 2008 and the beginning of 2009, which saw it fall from 5% in October 2008 to 0.5% in March 2009. Many people who already had tracker deals benefited massively from these cuts.

While some lucky people have existing trackers set at a very low percentage above or even at a percentage below the BoE base rate, in the current market you would be lucky to find a deal at “base rate + 2%”.

If you have just come off a fixed term tracker deal and are looking to remortgage, you are likely to be in for a shock – it’s almost certain you won’t get as good a deal as you had.

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Our recommendation

When deciding whether or not to take out a tracker mortgage, you need to take a stance on where you think interest rates are going. With the economy looking very uncertain and unpredictable at the moment, this is a tricky thing to do.

If you do foresee the BoE base rate staying at its historic low of 0.5% for some time, then a tracker mortgage could prove to be a great deal. However, there is always the danger that the base rate will increase and it’s essential to remember that by locking yourself into a tracker deal for a set period you are running the risk of having to pay increased monthly payments.

When looking at any deal you should ask yourself how you would cope financially if the interest rate increased by 1%, 3% or even 5%.

Your house probably the biggest purchase you’ll make in your life so before you decide on a mortgage, so it’s crucial to compare mortgages and consult a mortgage broker or IFA if neccessary.

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