Why discount mortgage deals are better than tracker mortgage deals

If you want a variable mortgage deal, Christina Jordan reckons you should you go for a discount over a tracker at the moment. Find out why...

If you want a variable rate mortgage (like a tracker or discount), it's probably for one of the following reasons:

1. You think interest rates are going to fall further (in which case you are bonkers)
2. You think that fixed rates are priced too high and would rather take your chances with a lower variable rate and therefore lower repayments
3. You think interest rates will not go up in the foreseeable future (or not by too much) and therefore you want the cheapest deal available now

Discounted and tracker rates both fit the bill for anyone who thinks this way, plus they are currently priced lower than their fixed rate counterparts, making them appeal to many borrowers looking for a cheap mortgage. And who can blame them?

Just 10 years ago borrowers had the limited choice of a fixed rate, which is set in stone, or a variable discounted rate, which moves up and down broadly in line with interest rates. Trackers were not on the mortgage radar in a big way but they have exploded in popularity over the last decade, as borrowers became big fans of their total transparency.

But what exactly is the difference between trackers and discounted rates?

Mirror movement

With a tracker rate your pay rate is set at a margin above or below another rate -- usually the Bank of England Base Rate.

For example, you might pay Base Rate plus 2.5 percentage points. This would currently mean a payrate of 3%, because the base rate is currently 0.5%.

 When the Bank of England decides to changes the Base Rate, your pay rate mirrors this movement at exactly the same margin. So, on the example above, if the Bank increased the Base Rate by 0.5% to 1%, your pay rate would automatically track up to 3.5%.

Many people like trackers because they are transparent and easy to understand. The lender has to move your payrate in line with Base Rate, and usually within one month.

Different perspective

A discounted variable rate is very similar, but your payrate is actually a discount from the lender's Standard Variable Rate (SVR). For example you might pay SVR minus 1.5 percentage points.

The lender's SVR moves up and down broadly in line with Base Rate and therefore so does your pay rate.

But crucially your payrate is not directly linked to the Base Rate, so the rate you pay does not necessarily mirror the movements of the Base Rate. Instead it mirrors the lender's SVR which lenders can peg at whatever level they want.

It is competitive market pressures and lenders' own circumstances and requirements that affect how they price their SVR, albeit heavily influenced by the Base Rate.

For example, the Base Rate could go down and the lender may or may not choose to pass this cut onto its SVR (and therefore to discounted rate borrowers).

But there is a plus side....

Discounted perks

The Bank of England Base Rate is currently at an all-time low and is certain to go up at some stage. Nobody knows when or how quickly but most agree that there is the capacity for it to rise significantly.

Those on tracker rates will see each and every increase to Base Rate passed onto their payrate.

Borrowers on discounted rates are likely to face similar increases, but their lenders have the discretion to decide not to pass on every single increase to their SVR, or to only pass on a portion of the increase.

They might do this to make their mortgages more attractive to new borrowers, or to retain customers. Either way, borrowers on a discounted variable rate would benefit.

To be honest, in the current environment I would be surprised if lenders didn't pass on most Base Rate increases to SVR. But if rates begin to rise quickly and the mortgage market becomes more competitive than it is now, some could well decide that not passing on all of the cuts in full would give them an advantage over rivals.

There is no such discretion for tracker borrowers as all increases will be non-negotiable.

Therefore, if I was currently choosing between a like-for-like tracker and discounted rate, personally, I'd go for the latter for the slim chance that future Base Rate increases may not be passed on in full.

The best deals

There's not much between discount and tracker pricing in the current market, although the mortgage market's lowest rate is HSBC's new 1.99% two-year discount.

If you want a lifetime or longer-term deal, trackers are certainly priced more keenly, while for those borrowing a high percentage of the property's value (90%) discounts are more competitive.

See below for my favourites of each at a range of loan-to-value levels:

Top trackers

*First-time buyer only

Deep discounts

*minimum of 2 applicants who must be graduates or professionals

Compare mortgages at lovemoney.com