Should you go for a fixed rate or a tracker? If you have a discounted mortgage deal that ends this year, here's how to choose the best deal.
Over the past three years, fixed rate mortgages have taken the lion's share of the mortgage market. And it's easy to see why. When interest rates are rising, borrowers with fixed-rate home loans are protected since their monthly repayments will stay the same. And even if interest rates do not rise, fixed rates provide borrowers with the peace of mind that comes with knowing exactly what your mortgage payments will be every month.
But more recently, tracker mortgages have become more popular. These deals `track' the Bank of England base rate. In plain English, this means if the base rate falls, then the interest rate on your mortgage must be reduced accordingly. So when interest rates fall, your monthly mortgage repayments will become cheaper.
Of course, the reverse is also true if the base rate rises, which is why - for borrowers who would struggle to meet their payments if their mortgage rate increased - a fixed rate is usually the better option.
Why Are Trackers So Attractive?
Many analysts are forecasting base rate reductions this year. If these predictions turn out to be correct and you're considering re-mortgaging this year, switching now to a base rate tracker mortgage could save you hundreds of pounds.
True, the Monetary Policy Committee (MPC), who is responsible for setting the base rate, chose not to apply a reduction this month. This meant rafts of borrowers with tracker mortgages felt no benefit. But many analysts still expect a base rate cut next month - and certainly rates are not expected to rise anytime soon, diminishing the attractiveness of a fixed rate.
That said, the outlook can change very quickly. Only a few months ago many experts thought the base rate could reach 6% by the end of 2007. But now the great and the good reckon that, in the current climate, it's more likely to fall by 0.5% this year, to just 5%.
What Tracker Should You Choose?
Because betting on the Bank of England is such a risky business, it's sensible to choose a flexible tracker mortgage which doesn't have an Early Repayment Charge (ERC). This type of deal will allow you to switch to a new mortgage deal without paying a penalty. So if the base rate rises, you can simply remortgage and take out a fixed rate. ERCs are usually charged as a percentage of outstanding your home loan (typically 3%), so could easily run to thousands, particularly if you have a large mortgage.
Secondly, don't be seduced by low interest rates or freebies. Although interest rates are important, you must consider the whole mortgage package. Deals with the lowest rates often have the highest fees. Product fees, for example, which essentially cover the cost of arranging your mortgage, can run to £1,000 or more. So make sure you look at the total cost of the loan (in How I Picked My Mortgage, my Foolish friend Donna Werbner explains how she calculated this -- or if you can't be bothered to work it out yourself, you can always speak to a fee-free broker).
Equally, the lowest rate deals may also come with a lower Loan-to-Value (LTV). The LTV is the amount the lender is willing to lend you as a percentage of the value of the property. So a 90% LTV means you must put down a 10% deposit. To be eligible for the lowest rates, you may find you need a larger deposit/larger amount of equity in your home.
When you're looking around for a new mortgage many lenders will try to entice you with free valuations or legal work. While that's all well and good, make sure these don't simply detract from a poor deal overall.
The table below shows a selection of competitive tracker mortgages that are currently available from The Motley Fool's whole of market mortgage service:
Lender | Rate | Term | Product Fee | LTV | ERC | Notes |
|---|---|---|---|---|---|---|
5.49% | 2 years | £999 | 95% | Yes | Free valuation & legal work for remortgages. No higher lending charge. | |
L&C Exclusive | 5.84% | 2 years | £0 | 75% | No | Refunded valuation. Free legal work for remortgages. Offset |
Saffron | 5.44% | 3 years | £699 | 85% | Yes | Refunded valuation for remortgages |
5.74% | Term | £845 | 80% | No | Free legal work for remortgages. Offset. Capped at 5.99% to 01/06/10 | |
Scottish Widows | 5.89% | Term | £199 | 90% | No | Refunded valuation. Free legal work for remortgages. Offset. Broker only |
As you can see Co-Operative and Saffron offer the lowest-rate mortgages which are actually below the base rate, but on downside they also charge an ERC if you want to switch early.
If you're prepared to pay slightly higher repayments, Hinckley & Rugby offers the next best deal - and no penalties will be applied should you choose to re-mortgage later on. But bear in mind, to be eligible for this deal, you'll need at least 20% equity in your home as the lender will only allow you to borrow a maximum of 80% of its value.
Consider A Lifetime Tracker
When you're shopping around for a new mortgage, take a look at lifetime trackers. As the name suggests a lifetime tracker is a mortgage which tracks the base rate throughout the entire mortgage term (so 25 years for a 25-year mortgage). So you'll never get stuck with your lender's more costly Standard Variable Rate (SVR), which most discounted deals automatically revert to. This could enable you to avoid the cost, as well as the hassle, of continually re-mortgaging every few years. But again, choose one with no early repayment charges so you can switch should the base rate rise.
A final word of warning: trackers may be the more competitive choice right now, but if you're on a tight budget and can't withstand any increase in your monthly mortgage payments, then avoid it like the plague. You'll be much safer with a fixed-rate mortgage instead.
More: What Does The Credit Crunch Mean For Re-mortgagers? | True Cost Of Buying A Home. When you decide to re-mortgage, check out your options at The Motley Fool's Mortgage Service.