Should you get a fixed, tracker or variable rate mortgage?

The difference between fixed, variable and tracker mortgages 

A mortgage is a big commitment, and knowing the difference between the available mortgages, as well as the pros and cons of each will help you choose the right product for your circumstances.

If you’re on a budget it is essential to know how much you have to pay each month. You might want to look into fixed-rate mortgages.

Do you expect to start a family or plan a career change in a year or two? Then you may want to look into something more flexible like a variable or a tracker mortgage. 

Let's take a closer look at variable vs fixed rate mortgage options.

What's a fixed-rate mortgage?

A fixed-rate mortgage means your interest rate is set until an agreed date. This is sometimes called the fixed-term, during which your monthly payments will stay the same, no matter what the Bank of England (BoE) base rate does. The base rate sets the level of interest that banks and building societies charge borrowers. 

A fixed-rate mortgage may sound attractive, especially when interest rates are low. But think carefully before committing for too long as some fixed-rate mortgages may have an early repayment charge (ERC). This is a fee you have to pay the lender if you pay in full – say, if you want to remortgage, for example, or if you move house – before the fixed-term is up, and it can be expensive.

At the end of the fixed-rate period, your repayments will switch to the lender's standard variable rate (SVR). This is the long-term rate of interest that the lender will charge and it's usually higher. The good news is you can always take out a new mortgage deal at this point if you don't want to stay on the SVR.

Pros & Cons of a fixed rate mortgage

Why choose a fixed-rate mortgage?

If you're on a budget, knowing what your mortgage repayments are each month is a great help. Or if interest rates are low, it can be attractive to lock these in. But when looking at the difference between a fixed and variable mortgage, think about how long you are committing yourself to the deal. With a fixed mortgage you are tied in for the term, and ERCs can be expensive if you want to move house or remortgage. However, If you are happy to be locked in for the agreed period, then a fixed-rate mortgage may be a good option.

Most fixed-rate mortgages allow you to pay more than the usual monthly amount up to a specific limit, (often 10% per year), without any penalty. Great if you get a windfall, but again, watch out for any penalties if you overpay.

What's a variable mortgage?

A variable mortgage is a mortgage where the interest you pay each month can go up and down (usually in line with the base rate). Some months you end up paying more, and others you end up paying less. As such, they make it hard to budget and are regarded as riskier.

Variable-rate mortgages generally come in two forms – standard variable and tracker. You will also find discounted variable mortgages. Let's consider each one in turn.

Standard variable rate mortgage 

A standard variable rate (SVR) is the standard interest rate charged by your lender. Typically, an SVR is higher than a fixed or tracker rate, so it is a more expensive way to pay back your mortgage. If the SVR goes down, then you pay less each month. But if the SVR goes up, you pay more. 

One key difference between fixed and variable mortgages is the risk of rate changes. Although an SVR tends to follow the base rate, the lender can move it up or down when they like. There is little chance of predicting when a lender will change their SVR, and because of this, they are seen as being a bit risky. As with all mortgages, though, there are pros and cons.

Pros & Cons of standard variable rate mortgages

Why choose an SVR mortgage?

If you anticipate life-changing events like a new job, new baby, or think you'll move home, an SVR offers flexibility. Choosing an SVR lets you move to a more competitive deal when you are ready. Because you won't have to pay an ERC for switching, the flexibility goes some way to offset the higher rate usually attached to an SVR mortgage.

Tracker Mortgage

A tracker mortgage is a type of variable mortgage where the interest rate you pay follows the BoE base rate. Your interest rate is an agreed percentage above the base rate. For example, if the base rate is 0.25* percent and your tracker is set at 1 percent above it, you pay 1.25 percent. If the base rate goes up to 0.50* percent, your tracker rate increases to 1.50 percent.

* for demonstration purposes only - the current UK base rate is 4.75%

If the base rate goes up, you will spend more without actually clearing a higher amount of your mortgage. The extra money just covers the increased interest charges. But when the base rate is low, they can offer some of the lowest mortgage rates.

Pros and cons of tracker mortgages :

Should I choose a tracker mortgage or fixed rate?

The main difference between a tracker and fixed rate mortgage is flexibility. In addition, because a tracker mortgage follows the BoE base rate (not your lender's SVR), it is more transparent. It moves in line with economic conditions, not the commercial decisions of the bank or building society. If the base rate decreases, then your mortgage repayments fall too. 

You can find tracker mortgage rates that run from two to ten years, and even life-of-mortgage tracker rates if you search. The longer a tracker rate lasts, the higher your agreed interest rate is above the base rate. Once it ends, you go back to the lender's SVR unless you remortgage.

Discounted Variable Mortgage

A discounted variable mortgage is at a reduced interest rate to the bank or building society's standard variable rate (SVR). The discount is usually for a short period (three years or less), but some lenders may offer longer discounted periods. 

Pros and cons of discounted variable mortgages

SVRs differ between lenders, so don't assume a bigger discount equals a lower interest rate. Check the lender's SVR as well as the discount being offered. For example, Bank X offers a 1.5 percent discount to its 5 percent SVR, so you pay 3.5 percent. Bank Y only has a 1 percent discount, but its SVR is 4 percent, you pay 3 percent. Bank X offers a higher discount, but Bank Y is the cheaper option.

How long should you lock in a fixed or tracker mortgage deal?

Whether you’re looking for a fixed or variable mortgage, incentives tend to run from two to 15 years, (though life-of-mortgage deals exist). Pick the wrong period, and it can cost you in fees and interest. Think about how closely you need to watch your budget, and how long you expect to stay in the property. In general, the longer you want the rate fixed, the more this certainty will cost.

Think about your future plans when locking in special incentives with variable or tracker mortgages too. Be clear if flexibility or certainty is more important when comparing fixed vs variable mortgages. Two-year offers usually come with the best interest rates, but refinancing every couple of years will see your fees add up.

Is a fixed, tracker or variable mortgage the best choice for you? 

Which is best for you – a fixed, variable or tracker mortgage? Look at your circumstances and first ask what's more important, certainty or flexibility?

Decide on an incentive period that's right for you. With both fixed or variable mortgage deals, most lenders impose early repayment charges to stop you chopping and changing for a better rate. If you end up having to refinance, move or sell during an incentive period, the costs can be considerable. As ever, look at the small print of any mortgage deal, not just the headline rates. The devil's always in the detail.