What is a fixed rate mortgage?
A fixed rate mortgage can provide financial stability.
With a fixed rate mortgage, the interest rate stays the same for a set period of time. This means that for every month during this set period, your mortgage repayments will remain the same.
This is in contrast to a variable rate mortgage, which will go up or down in relation to the Bank of England base rate, or your lenders’ standard variable rate (SVR).
The term of a fixed rate mortgage usually lasts between two to five years, but can be much longer. When this period comes to an end, your lender will typically transfer you automatically onto its SVR.
Fixed rate mortgage benefits
One of the main benefits of a fixed rate mortgage deal is the peace of mind it gives you. You know that during that set period your monthly mortgage repayments won’t rise, even if your lender’s SVR or the Bank of England base rate does.
This can help you to plan ahead and budget more easily for other household and day-to-day expenses, without being faced by nasty repayment surprises.
All this means that a fixed rate mortgage may be the right choice for you, if you’re on a tight budget and need the certainty and stability of a fixed monthly payment.
Fixed rate mortgage drawbacks
In the current low rate environment, where the next move in the Bank of England interest rate is expected to be upwards, fixed mortgages are a little more expensive than variable rate deals.
Furthermore, in the unlikely event that interest rates were to drop, customers on a fixed rate deal would not see any of the benefit.
What is a tracker mortgage?
A tracker mortgage is a type of variable rate mortgage. The interest rate tracks the Bank of England base rate at a set margin (for example, 1%) above or below it.
Tracker mortgage deals can last for as little as one year, or as long as the total life of the loan.
Once your tracker deal comes to an end, you’re likely to be automatically transferred on your lender’s standard variable rate (SVR). Typically, this will have a higher rate of interest.
Tracker mortgage benefits
In certain economic circumstances, borrowers can secure tracker mortgage deals with very low rates of interest. For example, with the current, historically low base rate of 0.5%, a +1% tracker mortgage would charge a rate of just 1.5% interest.
While your tracker mortgage rate is low, you can take the opportunity to overpay on your mortgage, shortening the total length of time it takes you to pay off your mortgage, and cutting the amount of interest you pay.
In addition, your rate is not dependent on the whim of your lender, it is not affected by changes in your lender’s SVR – just changes in the base rate.
Tracker mortgage drawbacks
On the other hand, as a variable deal, a tracker mortgage will not provide total rate security. If the base rate suddenly rises, so will the interest rate you pay.
This means that a tracker mortgage may not be suitable for someone on a tight budget, who needs to know exactly how much their monthly mortgage repayments will be. In these circumstances, it would make sense to choose a fixed rate mortgage instead.
If you want to leave a tracker mortgage deal before the end of the set term, you are also likely to be charged an early repayment fee.
What is a discount mortgage?
A discount mortgage is a type of variable rate mortgage. The term ‘discount’ is used because the interest rate is set at a certain ‘discount’ below the lender’s standard variable rate (SVR) for a set period of time.
For example, if a lender has an SVR of 5% and the discount is 1%, the rate you’ll pay will be 4%. And if the SVR is raised to 6%, your discount rate will also rise – in this case to 5%.
Discount mortgage deals typically last between two and five years. When your discount mortgage deal comes to an end, your lender will typically transfer you automatically onto its SVR.
Discount mortgage benefits
Having a discount mortgage means you can be sure that your rate will always remain below your lender’s SVR, for the length of the deal.
In certain economic circumstances (for example, when SVRs are generally low as a result of a low base rate) this may mean your discount mortgage deal has a very low rate of interest.
Discount mortgage drawbacks
Because your discount rate tracks your lender’s SVR – and you have no control over what that SVR is – a discount mortgage does not offer much rate stability.
And borrowers with large discounts below their lenders’ SVR may be in a particularly vulnerable position when their discount mortgage deals come to an end. This is because they could face large and sudden rate hikes when they’re transferred onto their lenders’ SVRs.
So, if you’re on a tight budget and need your repayments to stay the same from month to month, it makes more sense to choose a fixed rate mortgage.
In addition, you may well face early repayment charges if you pull out of a discount mortgage deal before the end of the term.
What is a standard variable rate mortgage?
It can be risky to stay on your lender’s standard variable rate mortgage
A standard variable rate mortgage (also known as an SVR or reversion rate mortgage) is a type of variable rate mortgage. The SVR is a lender’s ‘default’ rate – without any limited-term deals or discounts attached.
When a fixed, tracker or discount mortgage deal comes to an end, you will usually be transferred automatically onto your lender’s SVR.
A lender can raise or lower its SVR at any time – and as a borrower you have no control over what happens to it.
Who sets standard variable mortgage rates?
Standard variable rates tend to be influenced by changes in the level of the Bank of England’s base rate. However, a lender may also decide to change its SVR while the base rate remains unchanged.
Lenders’ standard variable rates typically range from around 2% above the base rate (currently set at 0.5%) to 5% above it or even more.
Standard variable rate mortgage benefits
For over two years, the Bank of England base rate has stood at an historic low of 0.5%. Most lenders have significantly cut their SVRs to reflect this.
So, if your previous mortgage deal has come to an end and you have been transferred onto a low SVR, you may be able to take advantage of that low rate by staying on it, and not looking for another deal.
Standard variable rate mortgage drawbacks
However, this is a very risky strategy – as a lender’s SVR offers no rate security. Several lenders hiked up their SVRs in the first few months of 2012, and more are expected to follow suit.
If you are on a tight budget and relying on your SVR to remain low, you’re in a very vulnerable position. In this case, it is very important you try to remortgage onto a fixed rate deal (which offers rate stability) before it’s too late.