Why going for a tracker is not so smart

A leading mortgage firm reckons trackers are the way to go at the moment. But are they jumping the gun?

Mortgage broker John Charcol is strongly recommending trackers: “In our opinion for borrowers not needing the security of a fixed rate, tracker and discount rate mortgages continue to offer better value.”

The last time it so strongly stated an opinion on using short-term trackers, back in late 2006 and through 2007, it turned out to be right, but some of its forecasts have also been spectacularly wrong. It failed to envisage the house-price crash and the difficulties that it would create for its own business, to the extent that it had to lay off staff, close offices and finally go into administration. It was saved by Towergate Financial.

John Charcol is basing its recommendation to track on its belief that the base rate will not start rising for about a year. Are they right? Does that mean we should choose trackers today over fixed deals?

Consider these scenarios

Four times in the past 36 years, rates have moved seven points or more inside two years. If that happened, not only would your tracker get very costly, but a fixed deal at the end of that is likely to look expensive, potentially hundreds of pounds a year more expensive than the current fixes.

But let's assume that worst-case scenario doesn't happen, and that John Charcol is correct: rates won't rise for about a year. John Charcol may then be right to say that to track now, you will pay less over the next two years. But what then?

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Let's say that at some juncture the base rate rises a whole point in one day. That's a very realistic scenario: the Bank of England has moved rates by that far, and that fast, 41 times in the past 36 years. Just a few years ago, the base rate moved 1.5 points in a day and 2.5 points in 29 days.

If the base rate jumps one point in a day, that's not a big rise in itself. That would add just £50 per month to an existing tracker mortgage. (Based on a £100,000 mortgage with 15 years left. You can do such comparisons easily for your own mortgage with our interest-rate change calculator).

From our current low mortgage repayments, that will be easy for most homeowners to tolerate.

Cheap for two years, expensive thereafter

But that's not the point. Consider what would happen to the advertised fixed deals when the base rate starts rising, even by small amounts, or even what would happen if large numbers of people suddenly just expect the rate to rise. There would be a massive surge to fix. The bigger the panic, the bigger the surge.

This will become a self-fulfilling prophecy.

A lender might then receive thousands or tens of thousands of applications for fixes in a short space of time. The first lucky customers will get the advertised fixed rate deal. Then disaster happens for the remaining applicants, whose forms are stuck in a backlog. The lender's pre-decided budget for the deal has been burned through. The lender introduces a new fixed deal with a higher rate. If the lender is particularly concerned about the new trend, it could be much higher.

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But still there are huge numbers of anxious applicants, and a backlog to process, and the next batch is also bought up. Many won't get in on that batch either, and the next fix could easily be even more expensive, especially if the base rate has risen again in between.

The tracker's dilemma

By that point, those of you with trackers are beginning to get anxious. Up until then, you might very well have paid less overall than those who fixed, but with interest rates continuing to rise and so much demand for fixed deals, the price of them is going up.

When you are released from your tracker deal and it is time to shop around again, you could have a dilemma. The fixes might no longer be near historical lows. Those five- or ten-year fixes you ignored back when you bought the tracker may now be looking a bargain. But they no longer exist for new applicants.

Fixes could now be much more costly, and you have to decide whether to bite the bullet and buy an expensive fix, or continue riding the roller-coaster. You could well pay another fee for the privilege of enduring this angst too.

Fix or stay flexible

The case to buy a long-term fix is harder to understand than the case to track for the short term. Fixing might not be cheaper in the long run, whereas tracking is definitely cheaper now, and the now is more familiar and easy to focus on. Too easy. Trackers are almost irresistible as a result.

The now can unduly influence our decisions, especially when you consider that paying for a house is a long-term commitment.

Fixed rates have risen a little in recent months, merely from the whiff of higher interest rates. However, looking back over the past 25 years, fixes have still rarely been cheaper than they are now, so if you are able to buy a five- or ten-year fix (your personal and financial circumstances permitting), there is a good argument for doing so now. You will lock in a good average rate, and ride out the roller-coaster in peace for a long while. It will cost you just one arrangement fee, too.

I don't need to argue the case for staying flexible by sticking with an SVR mortgage (or the rare tracker deals like first direct's, which has both low arrangement fees and no early repayment charges, and so it amounts to the same thing as an SVR).

It's clear that overpaying while SVR payments are cheap, or saving large amounts of money during that time, is a good solution. I approve of it as much as I do long-term fixes, provided you accept that you might have to pay a fair bit more to fix if you're not lucky enough to apply before the surge.

Cheap short-term trackers aren't the same. While you can overpay with them, they aren't as flexible as SVR mortgages, because you can't normally get out of them immediately without hefty penalties. If rates do start rising inside two years, buying a tracker could prove to have been a bit risky, as you might face a dilemma when your deal eventually expires. That is why I cannot feel as overwhelmingly positive about trackers as John Charcol does.

Relevant best buy fixed and tracker mortgages

The trackers in the table above no early repayment charges.

More: Compare mortgages through lovemoney.com | Ten steps to finding a mortgage | Save money with a tracker mortgage