Should I have a tracker or a fixed rate?
Should I have a tracker or a fixed rate?
26th September 2024: The information below was correct at the time of publication but is subject to change.
More and more people, especially first-time buyers, are coming to me saying that they would like to have a tracker or variable mortgage rate. However, when we then start looking at the numbers and what’s most important to them, in the end no more of them are opting for a non-fixed rate than they were a few years ago when interest rates were at rock bottom. Below are the things that I think first time buyers especially, forget to consider when assuming that a tracker mortgage is best for them.
If you are already confident on the different types of products you might want to skip to “If interest rates are falling, surely a tracker is best?”
What is a fixed rate?
It’s very much what it says on the tin. Your interest rate will be set at a known level for a set period of time. This is usually 2 or 5 years, but some lenders do have 3 year, ten year, and even full term fixed products. The lender can’t change the rate during the initial period regardless of the Bank of England Base Rate, or their own standard variable rate.
At the end of the initial fixed term, you would then go on to the standard variable rate should you not take any action. Though I of course contact my clients a few months before this happens to see what their needs are and usually arrange a new fixed product for them, or whatever suits their needs. This could be by taking a new deal with the same lender, or remortgaging to a new lender if a better outcome can be achieved.
Fixed products usually have early repayment charges if you repay the mortgage (for example switching to a new rate or lender or paying the mortgage off in cash or when selling the property) during the fixed term, but no penalty at the end of the initial fixed term.
What is a tracker rate?
Tracker rates specifically are interest rates that are linked to another instrument. They are usually a set percentage above or below the selected instrument for a set period of time, at the end of which they go onto the standard variable rate if no action is taken, as with a fixed product.
The most common instrument for trackers to be linked to is the Bank of England Base rate (BoEBR).
This means that if the lender offers a product at BoEBR +2% (the margin), and the BoEBR is 5% then you will pay an interest rate of 7%. If the BoEBR reduces to 4.75% then your interest rate will fall to 6.75%. The lender has to pass on the reduction, or indeed the increase if it goes the other way, to you. This is usually done within one calendar month.
Example
BoEBR | Lender rate | Rate you pay |
5.00% | 2.00% above BoEBR | 7.00% |
4.75% | 2.00% above BoEBR | 6.75% |
4.75% | 1.00% above BoEBR | 5.75% |
In this example it’s important to note that the lender themselves cannot change the rate or the margin for the initial period of the product.
Some trackers have early repayment charges but some don’t.
Other types of variable rates
Tracker mortgages are not the only types of variable mortgage rates though. Here is a quick overview of other types:
Standard Variable rate
This is usually the highest rate of interest on offer from a lender. It is the rate you go on to if you don’t select a product at the end of an initial period (fixed or otherwise). The lender can change it as frequently as they like and to whatever level they like with almost zero notice.
Usually there aren’t any fees or penalties for leaving a lender or repaying the mortgage when on this type of rate.
Discount rates
These are linked to Standard Variable rates (SVR). They work a bit like a tracker rate however there is an important distinction. They are usually expressed as a percentage reduction from the lender’s SVR. So, if the lenders’ s SVR is 7.99% and they have a discount product at SVR minus 1% then you will pay 6.99%. However, the lender can change their SVR at any time to any level regardless of what other lenders or the Bank of England are doing to the BoEBR. The BoEBR could decrease and a discount rate could increase.
Some discount rates even have early repayment charges so it’s not cost free to leave.
If interest rates are falling, surely a tracker is best?
Here is where I see people making a potential mistake. They think that if the BoEBR is expected to reduce in the near term, then over a 2-year initial term it would be cheaper to have a tracker rate. But guess what, if the banks also expect the BoEBR to fall over that time they aren’t going to leave themselves short changed.
This is why most trackers are currently higher than a comparable fixed rate with the same lender. If tracker rates and fixed rates were the same, and rates fell, sure it would be easy to see that a tracker rate should cost less overall, ignoring the risk that they may not fall, or even increase. Lenders know this and price accordingly.
An Example
Let’s compare two 2 year fixed rates (one with a £999 arrangement fee and one with no fees), to two 2 year trackers (one with a £999 arrangement fee and one with no fees) all from the same lender and see what we find.
On 23rd September 2024 Nationwide, the UK’s second largest mortgage lender with around 1 in every 8 UK mortgages was offering the following rates at a 90% loan to value (10% deposit) to first time buyers:
Type | Rate | Fees |
2 year Fix | 5.39% | £0 |
2 year Tracker | 6.19% (BoEBR + 1.19%) | £0 |
2 year Fix | 5.19% | £999 |
2 year Tracker | 6.15% (BoEBR + 1.15%) | £999 |
We can see that the no fee products have a 0.8% difference in their interest rates, and the products with a fee have a 0.96% difference in in interest rate.
Remember at the end of two years all the above would go onto the same SVR which is currently 7.74% with Nationwide so it only makes sense compare over the 2 year initial period.
Comparing the no fee products, let’s assume that over the course of 2 years the BoEBR reduced by 0.8% and therefore come the end of the product the rates are the same. It’s clear that you will have paid more on the tracker as you would have spent some time paying a higher interest rate than had you just fixed for that period.
Even if the interest rate comes down by more than 0.8% over two years, it does not mean that the tracker will cost less overall. This could be true even if the interest rate came down by 1.5% or even more over the two years.
This is because if for the first 18 months the tracker rate stayed 0.8% above the fixed rate, but in the last 6 months it was reduced and was 0.7% below the fixed rate, you would have still spent longer at 0.8% above the fixed rate than you did 0.7% below it.
So should you have a fixed rate or a tracker rate?
That is a personal decision, and it depends on you and to some degree your attitude to risk.
What I would say is that you shouldn’t try to predict interest rates. Anybody who says they know what is going to happen to interest rates and when, is guessing. Even the people who set the BoEBR called the Monetary Policy Committee disagree with what the base rate should do! For example, in February five of the committee member in charge of setting the rate voted to keep it the same, one voted to increase it, and one voted to decrease it.
So, what should you base your decision on? Base it on the things that you do know. These are usually things about you.
Consider, are you sure you’ll still be living here in 2 years’ time? If not, then a product with no early repayment fees may be more important that if it’s a tracker or a fixed.
Consider if you could cope with an increase in your monthly payment with no notice. And if the answer is yes, then ask, well should I have a fixed rate but for a shorter total mortgage term?
And finally, could you cope with the anxiety of every month knowing that ten people down in London get to decide if the amount you are paying is going up, down or no change? Or is there a value in having the certainty of your payment, especially if you know it’s going to start lower on a fixed than it is on a tracker in the first place?
Summary
Whatever you do, talk it though with your mortgage broker, and remember, your parents bought property decades ago in a different time and although their thoughts maybe of weight to you as they have had a couple of mortgages over the years, discussion with a professional who arranges a couple of mortgages a day is probably much more valuable.
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