When given the choice, would a borrower rather have a fixed rate mortgage or a variable rate mortgage?
In March 2009, the Bank of England base rate fell below 1%. Recent history shows that mortgage rates have gradually declined whilst the bank rate has remained mainly static. The proportion of fixed rate borrowers opting for 5-year fixed rates has significantly increased in recent years to take advantage of the low rates.
High rates of inflation have caused the Bank of England to act by increasing the base rate. The base rate is the single most important interest rate in the UK because it influences all other interest rates.
Higher interest rates make it more expensive for people to borrow money and encourage them to save. That means that overall, they will likely spend less. If people overall, spend less on goods and services, prices will tend to rise more slowly and that lowers the rate of inflation.
So, what has this done to the low fixed rates we’ve grown accustomed to over recent years? They’ve increased, making fixing a questionable choice for some mortgage borrowers in recent weeks. It’s also brought to centre stage the variable mortgage which we’ll explore in more detail and understand considerations for borrowers that hold a mortgage in a rapidly changing environment.
There are three types of variable mortgage – Tracker, Standard Variable and Discount Variable.
A tracker is a product which is a set percentage of interest that tracks above the base rate. For example – a 1% above base tracker at the time of writing this blog would give you an interest rate of 4% because the base rate rose to 3% in early November. If the same rate were in place and the base rate rose to 3.5%, the new interest rate would become 4.5%. The monthly payment, on a mortgage of £150,000 over 25 years, would increase by £42 as a result.
A standard variable product is a lenders basic interest rate which usually follows on from a products tie in period once it has finished. For example – a borrower may hold a 2 year fixed rate product @ 3.5%. That is known as the ‘tie in period.’ After the tie in period ends, this will naturally revert onto the lenders standard variable rate product which for this example is 5.25%. This rate is what your mortgage will revert onto if you don’t make arrangements to change the product to something more competitive (if available). The lender can change this rate at any time and at their discretion. It is not linked to the base rate and it is usually a higher rate than traditional fixed, tracker, and discount variable products.
A discount variable product is a discounted percentage rate of a lenders standard variable rate. They can change the standard variable at any time. As the standard variable isn’t linked to the base rate, it’s not a given that this rate will reduce or increase in line with it.
Most variable rate products hold little or no early repayment charges which makes them a viable option for borrowers who have a balanced approach to risk. A variable could allow them to benefit from a lower rate of interest and payments for a period of time compared to a fixed rate product but it holds no guarantees on when and/or if they will change in the product period. If they do change and bring concern to the future, the borrower can review their preferences and options and consider moving onto a fixed rate or product which suits their risk appetite.
When considering a variable of any kind, it’s important as a borrower to consider what expectation there is around any future changes to the factors that directly impact these products and what those changes would result in for the borrower.
If you’re looking for advice on which product is suitable for your needs, get in touch with us.
The Mortgage Lodge
November 2022