If a borrower wishes to pay the going rate on their loan, a variable rate mortgage is the obvious choice. These mortgages allow the borrower to benefit from cheaper monthly payments when interest rates are low, though they do not offer protection from future rate increases.
What is a Variable Rate Mortgage?
The most common variable rate mortgages are based on a standard variable rate offered by mortgage lenders. They generally set this rate in line with the movement of the Bank of England base rate, and although this differs between banks and building societies, the usual monthly interest payment at the present time is between 1.5% and 4% over this base rate. The rate paid moves with the base rate though sometimes lenders may decide not to pass on any rate changes to the customer, though this is unusual. Whatever the policy held, the variable mortgage rate will depend on the deposit initially put down for the property before mortgage repayments begin.
Variable mortgage rates therefore change every time interest rates do, which can greatly affect monthly mortgage payments for either better or for worse.
Advantages of Variable Rate Mortgages
These adjustable rate mortgages can have concrete benefits, the most apparent being that huge savings can be made when interest rates are low. They also allow for flexibility, for example if the borrower wants to overpay on their monthly bill, pay off their mortgage early, or take the option of remortgaging their property to get a better deal.
Disadvantages of Variable Rate Mortgages
However, with a standard variable rate mortgage, there is the danger of a large increase in Bank of England base rates, sending monthly interest payments soaring. These adjustable rate mortgages don’t provide the same financial security as fixed rate mortgages, since payments can be unpredictable.
Types of Variable Rate Mortgages
Variable rate mortgages can take different forms, a popular option being tracker mortgages. These work in a similar way to standard variable rate mortgages, though rather than being based on a lender’s standard variable rate, this mortgage tracks the Bank of England base rate. Tracker mortgages follow a set percentage above or below the base rate, so any movement within the base rate will also change the tracker rate by the same amount. This rate typically lasts between two to five years, though tracker mortgages which last throughout the full mortgage term are becoming increasingly popular due to the low interest rates offered. However because tracker mortgages are reliant on the Bank of England base rate, if interest rates rise, so will mortgage payments, meaning borrowers may find it difficult to budget and pay monthly bills, leading to the possibility of the borrower’s house being confiscated by the lender via mortgage repossession legislation.
As their name suggests, discount mortgages consist of an interest rate where a discount is applied to a lender’s standard variable rate for a set term. Like tracker mortgages, a discounted mortgage can be for an introductory term, or for the entire period of the mortgage. These mortgage types provide obvious benefits, offering huge savings throughout the discounted term. However, when using a variable rate mortgage calculator to compare discounted mortgages, it is important the actual interest rate being charged is taken into account as a non-discounted mortgage may actually have a lower standard variable rate than some discount mortgage rates. Mortgage fees should be included in the calculations also.