What is a variable mortgage?

With the Bank of England base rate currently at an all-time low, a variable mortgage may seem like an attractive option right now. But what happens if interest rates go back up? Here’s what you need to know about variable mortgages and how they work.

 

With the Bank of England base rate currently at an all-time low, a variable mortgage may seem like an attractive option right now. But what happens if interest rates go back up? Here’s what you need to know about variable mortgages and how they work.

 

Mark Gordon
From the Mortgages team
5
minute read
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Posted 2 SEPTEMBER 2021

What is a variable-rate mortgage?

A variable-rate mortgage is a type of mortgage that can go up or down depending on the economic climate. This means that the interest you pay on your mortgage, and therefore your monthly repayments, can vary each month.

The main benefit of a variable mortgage is that your payments will go down when the economy isn’t doing so well. The bad news is that they’ll go up again when the economy starts to recover. This means that you can never be 100% certain how much interest you’ll be charged from one month to another.

What are the different types of variable mortgage?

There are three main types of variable mortgage:

  • Standard Variable Rate mortgage (SVR)
  • Tracker mortgage
  • Discount mortgage

Variable mortgage rates can vary between lenders, so it’s important to compare different deals to make sure you’re getting the best value for money.

What is a standard variable rate (SVR) mortgage?

On a standard variable rate (SVR) mortgage, the interest rate is set by the lender. Although SVRs roughly move in line with the Bank of England base rate, lenders can decide to charge whatever rate they want, and move it up or down whenever they like. SVRs vary widely between lenders and can range from anything between two to five per cent above the BoE base rate.

The SVR is the rate that most lenders will put you on when your fixed-rate or discounted mortgage deal has come to an end. SVR mortgages are typically more expensive and the rate can be far higher than any introductory deal you may have been on before. They can also be risky as you never know when the lender will put up their rates. Even if the base rate is low, they may decide to increase their rates for commercial and economic reasons.

Pros

  • If interest rates are cut, your monthly repayments could go down too
  • SVRs don’t usually come with an Early Repayment Charge (ERC), so you can make as many overpayments as you like, or even pay off your entire mortgage without any penalties
  • You’re not locked in so you can remortgage to a cheaper deal whenever you want

Cons

  • Your rate can go or up down at any time
  • If interest rates rise, your monthly repayments will increase
  • SVRs are typically much more expensive than fixed rate or discounted introductory rates
  • SVRs are rarely available to new customers, and there are far more competitive deals out there anyway

What is a tracker mortgage?

A tracker mortgage tracks the Bank of England base rate and typically goes up or down in line with the base rate changes. This means that when interest rates change, your monthly payments will too.

Tracker mortgages don’t exactly match the BoE base rate – they are usually set at 1% or 2% above it. So, if your tracker mortgage is set at 1% above the current Bank of England base rate – which is at an all-time low of 0.1% – your interest rate will be 1.1% until the base rate changes again.

Pros

  • Trackers follow the Bank of England base rate so they’re transparent and easy to monitor yourself
  • Your interest rate is based on the official borrowing rate, not the commercial interests of your mortgage lender
  • Could be good value for money when the base rate is low
  • Some trackers don’t have Early Repayment Charges so it can be easier and cheaper to remortgage

Cons

  • Trackers are uncertain, so you’ll need to keep a constant eye on changes in the economy
  • If interest rates go up, so will your monthly repayments
  • Some trackers have a set ‘collar rate’, which means your mortgage rate won’t go lower than that if the base rate plummets
  • If your circumstances change and the rate goes up, you might not be able to afford your repayments and risk losing your home

What is a discount mortgage?

A discount mortgage offers you a discount on the lender’s standard variable rate (SVR) for an agreed time period – typically two or three years. Just be careful when comparing discounted mortgages. A bigger discount doesn’t necessarily mean a lower interest rate.

For example:

If a bank offers a 3% discount off an SVR of 5%, you’ll pay 2% for the agreed period. But if another bank offers a 2% discount off an SVR of 3.5%, you’ll only be paying 1.5%. So, even though the second lender offer less of a discount, the deal works out cheaper.

Pros

  • Your rate will stay lower than the lender’s SVR for the duration of the deal
  • If interest rates fall, so will your monthly repayments
  • Can be great value for money when the base rate is low

Cons

  • The discounted rate follows the lender’s SVR, which can change at any time
  • Some discounted mortgages have a collar, so your rate won’t fall below a certain level – this could become more commonplace after the economic uncertainty caused by Brexit and the COVID-19 pandemic
  • If you’ve managed to grab a large discount, you’ll be in for a shock when the deal ends, and you’re moved to the lender’s standard variable rate
  • Uncertainty – your repayments could change each month, making it difficult to budget

Variable or fixed-rate mortgage, which one is right for me?

This depends on your personal circumstances, financial situation and how much risk you’re willing to take.

With a fixed-rate mortgage, you have the security of knowing exactly how much your monthly repayments will be for a fixed period, for example, two or five years. You’ll also be protected if the interest rates go up, and it could work out cheaper if you grab a deal when interest rates are low.

On the other hand, you’ll be locked into your mortgage for the length of the fixed deal. If interest rates go down, you won’t benefit, as your repayments will stay the same. Fixed-rate mortgages often come with hefty penalties if you want to move to a new deal during your fixed period.

If you don’t mind the risk of an up-and-down economy and are confident that you can cover repayment costs if interest rates go up, a tracker or discount variable mortgage could be good value, especially while the base rate is so low.

But if you prefer the certainty of knowing how much your mortgage is each month, or changes to your monthly repayments could cause financial problems and stress, you’d be better off with a fixed-rate mortgage. Just remember that you’ll be moved onto the lender’s SVR at the end of your deal if you don’t remortgage.

Your home may be repossessed if you don’t keep up with repayments on your mortgage.

How to compare mortgages

Whether you opt for a variable or fixed-rate mortgage, it’s a good idea to work out how much you can afford to borrow. Our mortgage calculator can give you an idea of how much you might be able to borrow based on your salary and the amount of deposit you can put down. You can play with the figures and adjust the interest rate and mortgage length to see how the changes could affect your monthly repayments.

Frequently asked questions

What’s the difference between a tracker and discount mortgage?

A tracker mortgage works in line with the Bank of England base rate which can change with the economy. A discount mortgage follows the lender’s SVR which can change by any amount whenever the lender chooses.

What is a collar rate?

Some lenders will put a collar or ‘floor’ rate on their tracker or discount mortgages. This stops your monthly payments from going right down if the base rate plummets to an all-time low. Think of it as a kind of security for mortgage lenders. So, if your variable mortgage has a 2% collar and the base rate falls below 0%, as it has done over the last year, you’ll still have to pay 2% in interest.

How long do variable mortgages last?

Tracker and discount mortgages typically last between two to five years, although it is possible to get ‘lifetime’ mortgage deals which would last for the life of your mortgage, or until you remortgage to another deal.

SVR mortgages can last for as long as you want – but it wouldn’t be a good idea to stick with one. If you end up on an SVR, it’s probably best to try and remortgage to a cheaper deal as soon as possible. The only exception might be if you’re almost at the end of your mortgage. If you’re on the SVR rate and you’ve only got a small amount left to pay on your mortgage, the costs and fees involved with switching could outweigh the benefits of a lower interest rate on a new deal.

Where can I get mortgage advice?

If you’re not sure which type of mortgage is right for you, give our partners at London & Country Mortgages** a call. They offer fee-free expert advice to help you find the right mortgage to suit your needs. You can get in touch with their friendly advisers 0808 292 0811 or contact them below:

**London & Country Mortgages Ltd (L&C) are a multi-award winning mortgage broker with over 20 years’ experience in helping people secure their perfect mortgage. Advice is provided by L&C, who are authorised and regulated by the Financial Conduct Authority (143002).

L&C are not part of Compare the Market Limited. Compare the Market receives a % of the commission that our partner London & Country earns. All applications are subject to lending and eligibility criteria.

L&C will not charge you a broker fee should you decide to proceed with a mortgage.

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