It is automatic – particularly in these times of high interest rates – for borrowers to zone in on fixed rates when choosing a mortgage deal and ignore variable deals.
The certainty of knowing exactly what your monthly repayments will be for a set period of time is highly attractive. And with variable rates being directly impacted by the Bank of England base rate, fixed rates are currently a little lower.
It’s completely understandable the variable rate will fall under most people’s radar.
But that does not mean you should completely rule them out.
Indeed, there are certain circumstances and situations where they may prove the smart option and even if you are wholeheartedly convinced by a fixed rate, it’s worth knowing more about the alternatives for the future.
Here’s more about variable rates and who they are suitable for.
What are variable rate mortgages?
These are, as we’ve mentioned, a mortgage in which the rate moves up or down in line with a specified rate such as the Bank of England base rate or the lender’s own ‘bank rate’ – also known as its standard variable rate.
There are various types of variable rate – the most common one you’ll come across if you are in the process of taking out a mortgage is something called a tracker rate.
This will come in the form of a set rate – for example 1.5% – plus base rate. So, with base rate currently at 5.25% this will mean a borrower would pay 6.75%.
Standard Variable Rates (SVRs) are also come under this category. These are set by your lender and they apply to anyone who has a mortgage deal which has expired and hasn’t been renewed. You’ll automatically revert to this rate until you find a new deal. They can be altered at any time by the lender and are usually influenced by the base rate.
At the moment, according to Moneyfactscompare.co.uk, the average SVR is 8.17%. Compare this to the average two-year fixed rate, which is 5.79% and the typical two-year tracker which is 5.95%, and you’ll get an idea of where they all sit in the pricing charts.
The other kind of variable rate mortgage is something called a discounted rate. This one takes the lender’s SVR and adds a discount – for example 1.5%. For a lender with an SVR of 8%, a borrower would therefore pay 6.5% on their loan. In keeping with variable rates, this can change at any time.
How popular are variable rate mortgage deals?
At the moment 96% of new residential mortgages are taken out on a fixed-rate basis, according to UK Finance.
But Dean Scott, director of proposition and distribution at Newbury Building Society, explained it hadn’t always been this way.
Between 2005 and 2013 this figure was 37% and it topped 50% in 2010.
“The bank base rate reductions in 2008 and 2009 made variable rates extremely attractive for customers,” he said. “With inflation easing and lots of commentary predicting that we could see interest rates fall in August or September, is now the right time to be more seriously considering variable?”
The downsides of variable rate mortgages
If it is something you are ‘seriously considering’ it’s worth being aware of the potential pitfalls. Indeed, having an interest rate which is unpredictable is not the only reason to be cautious of variable rates.
“Variable rates are a bit more difficult to get your head around” Scott said. “Is it a tracker, is it a discount, is it the standard variable rate, does it or does it not come with an early redemption charge, somebody said I could overpay more, and why are you talking to me about floors and ceilings…it’s just all a bit too much when compared with the simplicity of a fixed rate.”
What’s more, at the moment, with interest rates high, variable mortgages are more expensive than their fixed-rate cousins.
The advantages of variable rate mortgages
One major ‘pro’ of the variable rate is they tend not to be so restrictive and can offer flexibility for customers who are not keen to be tied down.
Most fixed rates come with early repayment charges. So, if you lock into the current five-year fixed which, according to Moneyfactscompare.co.uk, is averaging 5.40% and then interest rates fall over the next year, there will be a penalty for leaving this deal and switching to a cheaper one. But this is not the case with SVRs or many trackers.
Scott said some customers might find it’s exactly what they’ve been looking for.
“Lenders have often had a more flexible approach to switching out of a variable product early,” he said, “and anecdotally, customers tell us when interest rates go up, they feel they are more manageable on a variable rate.
“Customers can absorb the increases as they go rather than the sudden demand and payment shock of coming off a fixed rate.”
Scott made another point. “The other thing that has made variable rates attractive to customers in the past is the differential in interest rates,” he explained, “ where customers can visualise one, two, or maybe even three 0.25% bank rate changes before they get to the price of a fixed rate.
“We are not in this position necessarily today, but it might only be a matter of time until we are.”
How to decide if you should take out a variable rate mortgage
We write this feature not to persuade you take out a variable rate – rather to offer you the insight into how they work so you are aware of the alternatives to fixed-rate deals.
In our recent article What mortgage is better? A two- or five-year fixed rate? the experts interviewed suggested a tracker or variable product could be a stopgap for someone who wanted to fix their rate but wanted to wait and see if interest rates came down.
But this suggestion was issued with a strong note of caution. Indeed, sitting on your SVR, which could be as high as 8.17% for months, could cost you quite a bit extra.
Scott added: “Ultimately, whether a variable rate mortgage is right for a customer will depend on their personal financial circumstances, and mortgage brokers and mortgage advice have a significant role to play here.
“Even if they are not right for some customers, it is clear variable rate mortgages have the potential to make savings for customers when interest rates fall, and it feels like we are on the precipice of that moment now.
“A bank base rate cut will likely be the jolt customers need to consider variable more seriously. Only time will tell whether some customers move before the bank rate does.”
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