Variable Rate Mortgages Explained

What is a variable rate mortgage?

A variable rate mortgage has an interest rate that can go up and down, meaning that your monthly mortgage payments will fluctuate as the rate does. This is different from a fixed rate mortgage, which has a fixed interest rate that has been set for a specific term. With a fixed-rate deal, you make the same monthly payments throughout the agreed term, such as 2 or 5 years.

Depending on the type of variable rate mortgage you choose, which we’ll explain below, the interest rate tends to follow an external rate, such as the Bank of England base rate. Using that as an example, if the base rate drops, your mortgage rate will drop as well and vice versa, if the base rate increases, so will your mortgage rate. Therefore, if you think market rates are going to decrease or they are already low and looking to stay that way for the foreseeable future, a variable rate can ensure that you have lower monthly payments.

Other types of variable rate mortgages have interest rates that are set by lenders and are changed at their discretion. This means that the rate and your subsequent mortgage payments can go up and down at any time and by any amount. Some variable rate mortgages also have a floor or ceiling. This means that there is either a level below which your interest rate cannot fall or a level which your interest rate cannot exceed.

As there are different types of variable rate mortgages available, such as tracker mortgages, discount mortgages and standard variable rate mortgages, you have more flexibility when choosing one. You can also benefit from lower costs, not just a lower interest rate, when compared with a fixed rate. The lender’s arrangement fee tends to be cheaper and, depending on the lender’s terms, there is often no early repayment charge to worry about if you overpay on your mortgage or leave your deal early.

How does a variable rate mortgage work?

With a variable rate mortgage, the interest rate can go up and down, causing your monthly mortgage payments to increase and decrease accordingly. Depending on the type of variable rate mortgage you have, the rate can be based on an external rate, such as the Bank of England base rate, or simply be set as your lender sees fit. If you choose a variable rate mortgage because its rate is cheaper than a fixed rate mortgage, just bear in mind that it could increase in the future. It’s important to note that if you choose a variable rate and it increases, causing your monthly payments to go up, you won’t be repaying a higher amount of your mortgage loan (the capital). Instead, you’ll simply be paying off a higher interest rate.

Some types of variable rate mortgages have set terms whereas others are ongoing. This means that some variable rate mortgages enable you to switch to a new deal or make large overpayments without being penalised by an early repayment charge (ERC). This is ideal if you need to move home more frequently than a fixed term would allow or want to pay substantial chunks off your mortgage loan early. An ongoing term saves you the trouble of having to change to a new deal each time your current one is due to expire.

Types of variable rate mortgages

There are different types of variable rate mortgages to consider, with the three main types being tracker mortgages, standard variable rate mortgages and discount mortgages.

Tracker mortgage

A tracker mortgage tracks an external rate, which is usually the Bank of England base rate. A set percentage is added to that rate for the mortgage interest rate. As the base rate increases, so does the tracker rate and, in turn, your mortgage payments. As the base rate decreases, the tracker interest rate lowers and so do your mortgage payments. This type of variable rate is easier to predict than the other types. Some tracker mortgages have capped or collar interest rates, which we’ll explain later on in this guide.

With a tracker mortgage, you have different options for the tracker term length. This is different from a fixed rate mortgage, which has a set fixed-rate term, such as 2, 3, 5 or 10 years. One option is to choose a tracker deal for an introductory period, such as between 2 and 5 years. Once this deal ends, you’ll automatically be switched to your lender’s standard variable rate unless you have arranged another deal to switch to. Another option is to keep the tracker rate for the entire term of your mortgage. This is called a lifetime tracker mortgage.

Tracker mortgages are usually subject to early repayment charges. This means that if you want to overpay by more than the annual allowance or want to leave your deal early, you’ll have to pay this cost, which can be very expensive.

Standard variable rate mortgage (SVR)

Lenders set their own interest rates for standard variable rate (SVR) mortgages rather than keeping in line with the base rate, for example. A standard variable rate can, therefore, change at any time and by any amount at the lender’s discretion. Not only is an SVR unpredictable but it also tends to be more expensive than other types of variable rates. Usually, you move onto the lender’s SVR once your introductory period has ended for a fixed, tracker or discount mortgage. That’s why it’s a good idea to look into new deals to switch to before your introductory deal ends.

As with all variable rates, if the SVR drops, so will your monthly payments. However, if the SVR increases, your payments will go up too. One benefit of a standard variable rate mortgage is that early repayment charges don’t usually apply. This means that if you want to repay your mortgage loan early or switch to another deal, you can do so without being penalised.

Discount mortgage

The interest rate for a discount mortgage is set at a discounted percentage to the lender’s SVR. As a variable rate, it can fluctuate, causing your mortgage payments to go up and down accordingly. As it’s linked to the SVR, which can change at the lender’s discretion, the rate you pay can change at any time. However, you can save money with this type of arrangement compared with paying the SVR as the rate will always be discounted.

As with tracker mortgages, you can choose the length of discounted term you prefer. This can be a short term, such as 2, 3 or 5 years, or you can have the discounted rate for the entire mortgage term. This is called a lifetime discount mortgage. Usually, the longer the discounted term, the lower the discount is. When comparing discount mortgage deals between different lenders, the amount payable can vary widely for the same discount percentage offered. This is because lenders set their own SVRs. Our mortgage brokers can compare the discount mortgage deals to ensure that you choose the one that’s best suited to your needs. Some discount mortgages also come with a collar rate, which we’ll explain below.

Offset mortgage

With an offset mortgage, you can choose between a fixed and a variable rate. Your savings account is linked to your mortgage and your savings are offset against your mortgage loan. This effectively reduces the balance of your loan and, therefore, the amount of capital that interest is charged on. This saves you money compared with a standard mortgage where interest is charged on the full mortgage balance. As a flexible arrangement, you can either pay less interest each month or decide to keep your payments as they are and reduce your mortgage term instead.

You can have an offset mortgage for any of the variable rate mortgages mentioned above as well as for a fixed rate mortgage. For example, you can choose a tracker offset mortgage, a standard variable rate offset mortgage or a discount offset mortgage. Just bear in mind that the interest rate charged for an offset mortgage tends to be higher to compensate for the flexibility offered.

What are collar and capped rates?

With a variable rate, a capped rate mortgage has an interest rate that fluctuates depending on the rate it is based on. This can be the Bank of England base rate, for example, or the lender’s SVR. However, a cap (or ceiling) is set by the lender, which is an upper limit that your interest rate cannot go above. This means that even if interest rates continue to rise, your rate won’t exceed the cap and your payments won’t go any higher as a result.

A capped rate mortgage, therefore, gives you some of the security that a fixed rate mortgage offers while also allowing you to benefit from lower payments if interest rates come down. This type of mortgage is hard to come by but, as we have unrestricted access to first and second charge lenders, our mortgage brokers can approach the lenders offering capped-rate deals on your behalf.

Opposite to a capped rate, a collar (or floor) is set by a lender, below which your interest rate cannot fall. This means that even if interest rates keep dropping, once your mortgage interest rate has reached the collar rate, it won’t go any lower. As such, your monthly payments won’t continue to decrease either. For example, you have a tracker mortgage with a collar rate of 1%. Even if the Bank of England base rate falls below 1%, your interest rate won’t go any lower than this. This arrangement protects the lender against interest rates falling too low and mortgages with collar rates are commonly available.

What happens when the variable-rate deal ends?

Unless you opt for a lifetime product, such as a lifetime tracker mortgage, you will need to agree on a set period for the variable-rate deal with your lender. Once this term ends, your interest rate will revert to the lender’s standard variable rate, which will be higher than your current rate. To avoid this, you can arrange a new deal to switch to before your current one ends. This can either be a product transfer with your current lender or a remortgage with a new lender. You can choose another variable rate mortgage or one with a fixed rate, depending on your needs and circumstances at that point.

Speak to an expert about variable rate mortgages

Our mortgage brokers – located throughout Kent, London and Edinburgh – are here to help with any of your variable rate mortgage queries. They can discuss your circumstances and needs before going through the different mortgage types with you. Once you’re sure that a variable-rate option is right for you, they can compare the deals available, including the different lenders’ terms and overall costs. That way, you can make an informed decision for your mortgage, whether you’re a first-time buyer, looking to invest in a buy-to-let property or ready to switch to a new deal.

To get started, give us a call on 01322 907 000. If you prefer, send an email to us at info@trinityfinance.co.uk or an enquiry via our contact form. One of our mortgage consultants will reply to you as quickly as possible with more information on variable rate mortgages. As well as arranging your mortgage, we can also assist you with other aspects of the property-buying process. These include arranging your home insurance and organising protection for your mortgage payments.

The costs involved with variable rate mortgages

As well as the interest rate, there are various other costs to consider when taking out a variable rate mortgage. These can include:

• An arrangement fee: This is charged by the lender for arranging the mortgage. The fee can either be paid upfront or added to your mortgage loan.
• Valuation and survey fees: A valuation is required by the lender to confirm the value of the property. A survey should be carried out to ascertain whether there are any defects in the property or repairs needed that you may otherwise be unaware of.
• Legal fees: These are paid to your solicitor or conveyancer for carrying out the legal work related to the transaction. This can include checking the title deeds and other documentation, carrying out searches, drawing up the contracts and handling money transfers.
• Stamp duty: You also need to factor in the cost of stamp duty in your budget when buying a property. The amount payable depends on the price thresholds your property falls under. Our stamp duty calculator can give you an idea of the stamp duty cost you’ll need to pay.

Standard variable rate mortgages are often offered with low or no fees compared with tracker or discount mortgages. They do, however, have higher interest rates. Some lenders don’t apply early repayment charges if you want to leave their SVR deal early. For example, if you want to switch to a new deal or repay your loan early. This is different from tracker and discount mortgages where early repayment charges usually apply. Our mortgage brokers can check how much the early repayment charges are and the lenders’ terms for their ERCs for the deals you’re interested in.

The advantages of variable rate mortgages

There are various advantages to having a variable rate mortgage. These include:

• Cheaper payments if rates fall: If your interest rate comes down, either due to an external rate it is tracking or because the lender has changed it, your monthly mortgage payments will be cheaper.
• A better interest rate: As you are taking on the risk of interest rates rising with a variable rate mortgage, lenders usually offer a more competitive rate than for fixed rate mortgages.
• A capped rate prevents higher payments: If you’re able to secure a capped rate mortgage, you can have peace of mind that your interest rate won’t rise above it. This ensures that your monthly payments never exceed that upper limit.
• Flexible term: For tracker and discount mortgages, you can choose the term you prefer. This may be to have a tracked or discounted rate for a short term, such as 2, 3 or 5 years, or a longer term, such as 7 or 10 years. Alternatively, you may prefer the tracked or discounted rate to last for your entire mortgage term.
• Make overpayments: You can usually make overpayments up to a set percentage of your outstanding loan balance each year without being penalised with an early repayment charge. This reduces the amount of capital that interest is payable on and helps you to pay off your mortgage earlier.
• Low or no fees in some cases: Lenders generally charge low or no fees for standard variable rate mortgages compared with other mortgage types. This includes early repayment charges, giving you the flexibility to switch deals or repay your mortgage early without being penalised. The interest rates for SVR mortgages are higher, though, and are set at each lender’s discretion.

The disadvantages of variable rate mortgages

As with any mortgage, there are disadvantages to consider too. For variable rate mortgages, these include:

• Changing payments: As the mortgage interest rate can go up and down, your monthly payments can fluctuate too. This makes it harder to budget.
• Higher payments if rates rise: If your interest rate continues to increase, your mortgage payments will become more expensive. As such, make sure that you have allowed for this possibility and can cover higher payments if necessary.
• A collar rate stops you from benefitting from even lower rates: If the lender has set an interest rate collar, your mortgage rate won’t go below this. This means that you won’t benefit from reduced payments if interest rates in general continue to decrease.
• Early repayment charge: Depending on your lender’s terms, you may be penalised with an early repayment charge if you wish to leave the deal early. For example, if interest rates rise, you may find it hard to keep up with the increasing mortgage payments and want to switch to a more affordable deal. However, you may have to pay an ERC but this can be very costly too.
• SVRs have higher interest rates: Whilst standard variable rate mortgages offer the most flexibility, they also come with higher interest rates. SVRs are set by lenders and can be changed at any time and by any amount.

Is a variable rate mortgage right for you?

When deciding whether or not a variable rate mortgage is right for you, you need to weigh up what’s more important to you and consider your view on risk. The fluctuating rate makes it harder to budget but you may benefit from lower rates for longer.

If you have flexibility in your budget and can cope with higher payments if the rate increases, this type of mortgage is worth taking advantage of when rates are low. You can use the dips to pay off some of your mortgage before the rate goes back up. This reduces the balance that interest is charged on, saving you money in the long run. You don’t always have to pay an early repayment charge with a variable rate mortgage, making it a more flexible option financially. This is another consideration if you know you’re going to have to move home soon and don’t want to be penalised when you need a new deal.

Therefore, if you prefer flexibility and cheaper costs over financial predictability, then a variable rate mortgage is ideal. If you’re averse to risk and prefer stability, then a fixed-rate deal is a better choice, giving you peace of mind that your rate and payments will stay the same.

When should you not consider a variable rate mortgage?

Whilst variable rate mortgages usually have lower rates than fixed rate mortgages, you take on the risk that interest rates can go up as well as down. Even small rate increases can have a big impact on your mortgage payments so you need to be sure that you can comfortably afford any increases. If an increase is going to put a strain on your finances, a fixed rate is a better option and one that allows you to budget properly.

Benefit from the flexibility of a variable rate mortgage

Whether you’re taking out a new mortgage or are coming to the end of your current deal, our mortgage brokers can discuss your circumstances and preferences to ascertain whether a variable rate mortgage is right for you. They can take into account your affordability and how this may change with various rate changes. When you’re happy to proceed and know the type of variable rate mortgage you want, they can compare the rates, terms and costs of different deals. This will allow you to make an informed decision on your mortgage product.

To find the best deal for your needs, give us a call on 01322 907 000. Alternatively, send us an email at info@trinityfinance.co.uk or an enquiry via our contact form. One of our mortgage experts will reply to you with further information on the variable-rate options available. We have access to exclusive deals that aren’t offered to the public by lenders so you can rest assured you’ll be offered the best rates.