Forget fixes and turn to trackers

As Base Rate trackers fall to an all-time low their appeal is undeniable

Choosing between a fixed or tracker rate is one of the biggest mortgage decisions you will have to make. And there is currently a big difference in cost.

The average rate on a two-year tracker mortgage has fallen to 3.40%, its lowest ever level according to financial information provider Moneyfacts.

In contrast, the average rate on a two-year fixed rate mortgage has increased to 4.59% - its highest level in 10 months.

On a £150,000 repayment mortgage that’s a monthly difference in repayments of £98, or £2,352 more for the fixed rate over the two-year duration.

While many people clearly think it is worth paying a premium for the security of a fixed rate there are also lots of borrowers who would rather get the cheapest deal available for their needs now.

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Cheap and cheerful

It is almost certainly the case that a tracker mortgage will be cheaper than an equivalent fixed rate, whatever your circumstances.

Rates start at just 1.99% if you have a large deposit and from 4.29% for those with only 10% upfront.

What this does is minimise your monthly repayments, as the example above shows, which can be great if you have just bought a property and have other expenses to consider, like furnishing your new home.

It also means that if you have surplus income you could choose to overpay your mortgage and reduce your debt more quickly -- most mainstream lenders will allow you to overpay 10% of the property’s value each year.

But while they may be great right now there is one very obvious problem with tracker rates -- and the clue is in the name.

Over-exposed?

Because trackers literally track the Bank of England Base Rate you are left exposed to rising interest rates.

The Base Rate is currently at a record low of 0.5%, where it has been for two years, so the only way is up. And this means that everyone on a tracker mortgage is at risk of their monthly repayments rising.

Say you currently pay a tracker rate of 2.5% (Base Rate plus 2%). On a £150,000 repayment mortgage your monthly repayments would be £673.

If interest rates rose by 0.5% and your pay rate went to 3%, your monthly repayments would rise to £711, an extra £38. Perhaps that’s manageable.

But what if they then shot up to 4% (still way below their long-term trend) meaning your repayments were £792 a month?

Is an extra £119 a month manageable? Perhaps not.

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And that’s why some borrowers prefer the safety of a fixed rate. It’s the only way to guarantee that your repayments will not rise for an agreed period.

Of course, financial matters are not always so black and white.

The grey area

For many people the crux of the matter is how likely rates are to rise by a level at which trackers become more expensive than fixed rates.

With average overall trackers more than one and a half percentage points lower than average overall fixes (3.48% compared to 5.03% according to Moneyfacts), the Bank of England would have to increase its Base Rate from 0.5% to 2% before average trackers became more expensive.

Many believe that this is not likely to happen over the next two years or so, the typical duration of a short-term mortgage deal.

Then there is a further twist. Because for every month that rates stay low, the tracker borrower is gaining an advantage. It’s not just about how far rates will rise over the coming years, but how fast.

Some argue that there would have to be a sharp shock to interest rates now for trackers to look unattractive over the next few years.

One leading mortgage pundit, John Charcol’s Ray Boulger, summed this up recently in terms of the deals available right now. He said that “A gap of at least 2% between the best variable rates and the best five year fixes is only justified if Bank Rate rises relatively quickly and averages at least 2.5% over the next five years.”

The first of those points -- that rates will rise quickly, seems unlikely given the noises coming from the Bank of England and the ongoing fragility of the UK economy. Indeed, the second revision of GDP in the last quarter of 2010 to minus 0.6% suggests that rates may not be rising anytime soon, or at least by little more than a token 0.5%.

As for the second point, about whether Base Rate will average 2.5% over the next five years, there is no way of predicting that with any clarity.

If you want long-term rate security a five-year fixed rate could be your best option.

If you want the cheapest rate now, combined with a good chance that you will pay less over the next few years, a tracker could be perfect. Just ensure you can afford to be wrong in case rates do spiral.

Below are some of the top trackers on the market, whatever your deposit:

20 top trackers

More: Find a competitive mortgage | The best mortgages are found off the high street! | High interest rates will crash property prices

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This article aims to give information, not advice. Always do your own research and/or seek out advice from an FSA-regulated broker (such as one of our brokers here at lovemoney.com), before acting on anything contained in this article. 

Finally, we tend to only give the initial rate of a deal in our articles, but any deal which lasts for a shorter period than your mortgage term may revert to the lender's standard variable rate or a tracker rate when the deal ends. Before you take out a deal, you should always try to find out from your lender what its standard variable rate is and how it will be determined in the future. Make sure you take all this information into account when comparing different deals.

Your home or property may be repossessed if you do not keep up repayments on your mortgage.