Mortgage Guides

Variable-rate mortgages

By Becca Talbot becca.talbot@consumerchoices.co.uk

This guide will explain everything you need to know about variable rate mortgages - how they work, the advantages and disadvantages, and who they might suit... (Updated 30/9/09)

If you are looking to buy a house 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
• Who would a variable-rate mortgage suit?
• Our recommendations

What is a variable-rate mortgage?

Put simply, a variable rate mortgage is a mortgage with a variable rate of interest.

The rate you pay may be pegged to the Bank of England base rate, 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.

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 better option for you. You should speak to an independent mortgage broker to get impartial advice and information. Plus, it's 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.

Guide: Fixed or tracker mortgage - Which sholud I choose?

Sign up to our Money news RSS feed to make sure you stay on top of changes in the Bank of England base rate.

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 that you are put on automatically 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 SVRs have not.
2. Tracker – Tracker products follow the base rate at a margin above, for example "base rate + 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 recent 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 appliers 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 free to remortgage.

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 of purchase, interest on variable rate mortgages is usually lower than the lender’s fixed-rate equivalent – so you should start off paying less.

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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.

Who would a variable-rate mortgage suit?

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.

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 and consult a whole-of-market mortgage broker to ensure you get the best deal.