Right now a lot of borrowers will be scratching their heads when their broker raises the possibility of them taking out a tracker or discounted rate, which will see their monthly payment go up if the Bank of England raises rates further.
Most agree a rate rise is likely as the BoE seeks to control runaway inflation. But I am doing my own remortgage right now and have decided to go down the tracker route.
Sounds mad with rates rising, right? So why am I doing this? Let me explain.
The key takeaway is that the premium you currently have to pay for the security of a fixed rate, over and above a tracker or a discounted variable rate, is around 2.5 per cent to 3 per cent.
That’s a chunky premium. And it’s a premium that may take some time to come down, despite the fact the BoE has now hinted that the bank rate may not breach even 5 per cent.
Indeed, anyone taking out a tracker or discounted variable rate must be prepared for an increase in their monthly payments. In fact, it’s almost inevitable.
The markets are pretty certain that rates are going up, but if you don’t think they’re going to rise too high, a tracker mortgage is definitely something to be discussed with a broker.But even with further rate rises, the important bit to understand is that you could still be paying less on a tracker for some time yet.
There’s also the fact that some lenders have introduced tracker rates that are penalty-free while others have options to switch in-house onto a fixed rate at any time without an early repayment charge.
This is good for someone who may want to exit a tracker and lock into a fixed rate for added security. It gives them flexibility and peace of mind.
How would it work?
To illustrate how this all works in practice, below is a breakdown of the monthly payments on a variable tracker moving up to the fixed rate equivalent and then falling.
Assumption: First-time buyer; 90 per cent LTV (£270,000 ); 25 years repayment mortgage.
Option 1
Two-year tracker at 3.54 per cent (base rate plus 0.54 per cent). Monthly payment: £1,358.
Monthly payment should base rate rise to 5 per cent (pay rate 5.54 per cent): £1,684.
Option 2
Two-year or five-year fixed at 5.6 per cent. Monthly payment: £1,693.
A tracker rate, in this example, gives an initial saving of approximately £326 a month when compared with the fixed rate equivalent.
Now, as the BoE base rate increases, that saving will naturally erode but until the rate reaches the fixed rate, the borrower is in the money.
For some borrowers, of course, the saving may not warrant taking the risk with a tracker and they may opt for a fixed rate instead. It all comes down to a person’s appetite for risk and personal circumstances.
More considerations
What’s important is that they take advice from an independent mortgage broker and make an informed decision.
Other factors that should be taken into account are:
- Level of savings to handle unexpected payment shocks.
- Level of current debts and how well managed they are.
- Level of income over expenditure.
- Future earnings expectations.
- Future commitments.
- Future plans to move within the product term.
- Likelihood of lender offering a follow-on product.
- Credit profile.
- Desire to extend the term to lower the monthly payments.
- Consider an interest-only mortgage (subject to qualification criteria) as an interim measure before switching back to capital and interest.
Once these have been considered, clients can make an informed choice and elect to go for a tracker mortgage should they feel comfortable with that.
If there are any doubts, then a fixed rate may be more appropriate, despite the fact it will cost you more.
Ultimately, the expected trajectory of future rates is the biggest factor when making the decision about whether to fix or not.
The markets are pretty certain that rates are going up, but if you don’t think they’re going to rise too high, and are happy with the risk, then a tracker or discounted variable rate mortgage is definitely something to be discussed with a broker.
Bob Singh is founder of Uxbridge-based Chess Mortgages
