The wide range of mortgage rates on the market has always been confusing, but the picture is complicated by the fact that the Bank of England base rate has now been at a record low of 0.5% since March 2009. That doesn’t mean there’s an undisputed “right” answer as to which rate type is best for you, but it does change some of the factors you need to take into account.
The Standard Variable Rate is the simplest type of mortgage and means that the lender decides what your interest rate is at any time. This is usually decided by a combination of the Bank of England base rate and the competition in the mortgage market. Traditionally the advice has been to go for this if you don’t mind taking the risk that rates will rise. In today’s climate, the standard rate is still very affordable for many people, and there’s no sign of it changing soon: the most recent Monetary Policy Committee meeting saw a unanimous 9-0 vote to keep the rate unchanged. Bear in mind, though, that while the timing is uncertain, it’s as certain as can be that the rate will change in the long run, and there’s only one direction it’s going to move in: up.
What about a fixed rate? Well, it’s still a form of gamble as you are effectively predicting the variable rate won’t go below this fixed rate. While lenders may offer a fixed rate at any time, it’s most common at the start of a loan, for anything between one and five years. Before taking out such a deal, you should find out whether there are any penalties if you decide to pay it off early, for example by re-mortgaging with another lender for a lower rate. You’ll also need to check what happens to the rate at the end of the fixed period: usually it shoots up to the variable rate, which could mean a significant hike in your monthly costs if the Bank of England has decided it’s time to tackle inflation by then.
You could also opt for a tracker rate, in which the rate you pay is directly linked to the Bank of England base rate, for example being half a percentage point higher. The effect is that your costs can be affected by the Bank of England’s decisions, but not by the bank’s own variations. Given that banks have been so hesitant to take risks on loans that there’s not as much competition in the market as usual, you can effectively look at this in the same way as the standard variable rate.
Another option is the cap and collar, another fixed-variable hybrid. A cap rate means you have a variable rate but, during a specified time, it can only rise up to a certain level. A cap and collar rate works the same way, but there’s also a minimum level, meaning you don’t benefit even if market rates go below this. For some borrowers this can be an effective compromise between having relatively low rates but reducing uncertainty.
All in all, the mortgage rate game remains as much of a game of predictions as ever. Fixed rates offer more certainty, while variable rates are a more explicit gamble, with tracker or cap/collar rates somewhere in between. Right now the premium you pay for a fixed rate (and thus the savings that come with the variable rate) is relatively low. That said, even if you make a rate decision based on the on-going low Bank of England base rate, you should still at least consider how you’d cope if your payments rose rapidly.
This article was written by Principality.
Photo by Richard Webb.