Is it time to consider a tracker mortgage?
With interest rate increases now thought to reach a peak sooner than expected, is now a good time to consider a tracker mortgage?
What is a tracker mortgage? – A basic overview.
For more information on what a tracker mortgage product is please see our mortgage A-Z here.
Tracker mortgage products are a type of variable mortgage interest rate that can move both up and down depending on certain things happening. Typically they “track” above or below a benchmark scale and the most common of these is the Bank of England’s base rate of interest. So for a simple example, assume you have a tracker mortgage at +0.50% above the Bank of England base rate. If the Bank of England based rate is 5.25%, as it is at the time of writing, then the rate of interest you would pay will be 5.75%.
Should the Bank of England decide to reduce their base rate by 1.00% to 4.25%, the rate of interest you would now pay will remain +0.50% above this newly reduced benchmark. So in this example your new mortgage interest rate would be 4.75%. A decent saving I am sure you will agree.
However it is always worth remembering that the benchmark rate can change in both directions. It can increase just as easily as it can decrease. Therefore, an upward movement to the Bank of England base rate to say 6.00% will of course mean that your payable mortgage remains +0.50% above this at 6.50%. So this no longer looks quite so attractive.
Tip: Always check what the benchmark rate of interest will be as it wont always be directly linked to the Bank of England base rate.
Should I consider a tracker mortgage now?
Generally speaking, tracker mortgages have been marginally lower in cost than their fixed rate counterparts at the outset. As there will always be an element of risk involved when choosing a product that will fluctuate. There has to be an incentive when choosing a variable rate mortgage over a fixed rate option. Typically this will be a lower initial monthly repayment, an enhanced level of flexibility or both.
As a general rule, considering a tracker mortgage when the benchmark rate is already very low only leaves room for potential rate rises. We have seen this recently with the Bank of England (BOE) base rate increasing from 0.10% in December 2021 to 5.25% in September 2023.
At 0.10%, the BOE base rate couldn’t really go much lower so further decreases were unlikely. The thought process for considering a tracker at this point would indicate a belief that rates would remain low and stagnant, or may increase a little before perhaps dropping back again.
If you picked a track rate product at BOE +0.50% in December 2021, your initial payable rate would have been just 0.60%. Very nice !
However, less than 2 years later, the very same product would give you a payable interest rate of 5.75%. This is a huge increase. In this case, a slightly more expensive fixed rate at the outset would have most likely been a better option.
What about when the benchmark rate is high?
Trackers begin to look more attractive when the benchmark rate is relatively high. Ideally, a benchmark rate needs room to drop downward from its current level to offer maximum benefit. This is especially the case when the market feels that interest rates are at or nearing their recent peaks. It may mean that the most likely direction of rates will be downwards if there is little scope or reason to increase the benchmark further. Of course predicting when peak level has been reached is something that cannot be guaranteed so some risk always remains.
However, there are plenty of compelling arguments out there to suggest that we may be close to a recent peak for the BOE base rate. This makes tracker mortgages more attractive than they have been for the last couple of years.
5 good reasons to consider a tracker for your next mortgage product.
1. Lower initial monthly repayments.
This means that your monthly repayments may be lower when you initially start your new mortgage.
I have checked the market today (13th September 2023) for comparison purposes assuming a 30% deposit.
Of the 2 year fixed rate deals available, one of the best was a 5.68% option with a £999 fee. However, a similar fee tracker was offering +0.19% above the BOE base rate. Giving a payable rate of 5.44%. This is 0.24% below the equivalent fixed rate alternative.
In addition to the lower interest rate, the tracker also featured limitless overpayments. Plus no penalties for switching to another product / lender within the 2 year lifetime of the deal.
Therefore, even if the BOE base rate were to increase by 0.25% when the Monetary Policy Committee meet on the 21st September, the payable rate on the tracker would still be around the same as the fixed option. It would also retain the chance of potentially dropping back down over the next 2 years. Plus the ability to jump ship and lock in a new deal without penalty is always a nice benefit to have.
Always ensure you can afford your mortgage repayments in the event of further rate increases in the future. Do not rely solely on the initial monthly repayment as a guide to future costs.
2. Flexibility
Many tracker mortgages offer flexible features not available with a fixed rate product. Sometimes these features alone are of more value than the rate of interest itself. Options to look out for include:
No early repayment charges.
Gives you flexibility to swap to another deal / lender at any time without incurring any early repayment penalties. This can be used if a great deal arrives elsewhere or if rates are expected to increase. Likewise, its handy if you feel rates have bottomed out and you would like to lock a low fixed rate in place.
It can also be very useful if you are considering the sale of your property in the near future. No early repayment charges to pay means you can maximise equity from the sale and boost your onward deposit. You can also complete the sale at any time instead of waiting for an early repayment charge period to expire.
Offset.
Offset accounts are provided by some mortgage lenders and run alongside your main mortgage account. They are effectively savings accounts designed to help you repay your mortgage early. They do this by limiting the total amount of interest payable over the term. Any money you save in these accounts wont accrue any interest. However, they offset against the interest charged on the same amount of your mortgage.
For example, assume you have £25,000 in savings. You also have a mortgage rate of 6.00% on a balance of £100,000. You could choose to move the £25,000 of savings into your mortgage offset account. This means that the rate of 6.00% would only be charged on the remaining £75,000 mortgage balance not covered by the savings in the offset account
As your mortgage repayment would remain the same each month you are effectively overpaying the mortgage and paying it off quicker. This is because you are paying less interest overall due to the offset account. You will also retain access to the full £25,000 should you need it.
Your own personal tax liability can affect how effective offset accounts will be so it is always worth disusing the benefits with a professional and by using offset calculators.
Unlimited overpayments.
If your mortgage has the benefit of no early repayment charges, then it will almost always feature the ability to make unlimited penalty free overpayments. This means that you can pay off as much of you mortgage as you wish. Either in a lump sum or with regular overpayments. This can save you a lot of interest over the term of the mortgage.
3. Switch to fix.
Of course the hope is that your tracker mortgage will follow the benchmark rate downwards and lead to lower monthly repayments. However, the rates may also increase and monthly costs could rise.
Firstly you could ride it out and hope for a rate decrease in the future but there is no guarantee. Secondly, some products may allow you switch from your tracker to a fixed rate on the lenders range at the time. This is useful if you feel that your tracker mortgage is becoming unsustainable in the long run. Often this can be done without incurring an early repayment charge.
This is handy if rates are predicted to rise considerably and stay at a sustained level thereafter. The main drawback is that the fixed rates on offer may be a little higher than they were at the outset. Plus you are limited to those on offer from your existing lender.
4. Good alternative to a longer term fixed when rates are high.
Across the market we are currently seeing the best fixed rate deals available with tie-in periods of 5-10 years. However, that does not mean they are necessarily attractive in the long term.
Lengthy tie-in periods may not sit comfortably with people who feel that interest rates are peaking and may drop back down over the coming years. Opting for a tracker short term may mean that it buys them more time to review what happens. The longer term fixed deals may themselves start to reduce if their rate predictions were accurate. They can then of course hop off of their tracker when they feel that the longer term deals are at a more affordable level.
5. Can sometimes be taken for the lifetime of the mortgage, or for short periods.
Some trackers are lifetime products and can track the BOE base rate for as long as the mortgage is active. In the past we have seen products follow the BOE base rate at -0.99% for the term of the loan. Needless to say this is a pretty good deal even now.
Alternatively they can be treated as a short term options especially if they have the flexibility of no early repayment charges. This is good for planned house moves, upcoming changes to the mortgage i.e. additional borrowing etc, and also if there is a separation / divorce in progress.
Final note.
Typically speaking, when deciding on whether to opt for a tracker mortgage it will depend on whether your personal preference is for stable monthly repayments or if you feel that market conditions may improve and you would like to take advantage of this. Variable rates are risky by nature, so expect your monthly repayments to fluctuate in both directions and ensure that they remain affordable. Flexibility can be valuable, so don’t always concentrate on the headline rate of interest in isolation. Look out for Caps and Floors which are limits to how high or low a tracker can go.
For more in depth details relating to tracker mortgages, please check out the mortgage A-Z section.
Post compiled by Grant Carpenter CeMAP, CeFA – 15 years of regulated mortgage advice.
Please note that the content listed within this post is purely for information purposes only and does not constitute advice.
