When it comes to applying for a mortgage, you’ll most likely end up on one of three types of deal: fixed, variable, or tracker.
While fixed-rates are often the favoured choice, many borrowers prefer the benefits of a tracker-rate deal.
So, how do they work, and could they be right for you? Read on to discover the advantages and disadvantages of a tracker-rate mortgage.
Tracker-rate mortgages typically follow the Bank of England base rate
As the name suggests, a tracker mortgage rate typically follows the Bank of England (BoE) base rate.
The base rate is essentially an interest rate that the BoE pays on cash that commercial banks and building societies hold with it. The BoE assesses the base rate monthly, adjusting it as required to meet its targeted inflation rate of 2% per year, depending on factors in the wider economy.
For example, if spending levels are high, the BoE will typically raise the base rate to increase interest rates on savings accounts, but also mortgages and loans. This helps to reduce spending and encourage saving.
By contrast, if spending levels are low and the BoE wants to stimulate the economy, they will lower the base rate.
This happened early in the coronavirus pandemic. Back in March 2020, the BoE cut the base rate to 0.1% to encourage banks to lend and people to spend their money to kickstart the economy.
Tracker-rate mortgages work by using the BoE base rate to determine the interest rate. According to Money Saving Expert, tracker-rate mortgages usually track around 1% above the base rate.
This means, whether the BoE’s base rate rises or falls, your mortgage rate will change with it. Depending on how the rate performs, this could impact your monthly mortgage payments.
Advantages of a tracker-rate mortgage
A mortgage rate that changes with the base rate provides a range of potential advantages.
If the base rate falls, so will your repayments.
The most obvious advantage of a tracker-rate mortgage is that if the base rate falls, so will the cost of your repayments.
If the base rate falls by 0.25%, the interest rate you’ll pay on your mortgage will typically also fall by 0.25%, resulting in lower repayments.
Your lender cannot choose to change your rate.
When you take out a variable-rate mortgage, your lender can change the rate you pay at any time. They have control over their standard variable rate (SVR) so you could see your repayments rise and fall whenever they decide.
A tracker rate only changes when the rate it is tracking (typically the BoE’s base rate) changes. This protects you from your lender suddenly raising your rate.
When the rate does fall, you may be able to overpay on your updated charge.
If the rate falls and brings your repayments down, your lender may allow you to keep paying the same amount you paid previously. By overpaying, you could reduce the overall cost of your mortgage, or pay your mortgage off more quickly.
Some tracker-rate mortgage products have an upper-limit cap.
While not being that common, there are some tracker-rate mortgage products that have an upper-limit “cap” on your rate. This means that, when the BoE’s base rate rises to a certain point, your rate will stay level at the pre-agreed maximum cap.
Having a capped tracker-rate could protect you from a spike in the base rate and a sharp rise in your monthly repayments.
Tracker-rate mortgages can offer greater flexibility if there are no early repayment charges
A tracker-rate mortgage can give you the flexibility to make extra payments, as many of them don’t have early repayment charges.
This contrasts with fixed-rate mortgages, most of which have early repayment charges if you pay off some or all of the mortgage within the fixed-rate period.
So, if you wanted a mortgage now but knew you were going to move in a year, or that you were going to receive an inheritance that you wanted to use to repay your mortgage, a tracker-rate may allow you to do this without having to pay early repayment charges.
Disadvantages of a tracker-rate mortgage
Naturally, there are also downsides to having a mortgage that tracks the base rate.
If the base rate rises, so will your repayments.
In the same way you can benefit from a drop in the BoE’s base rate, you may also be worse off if it rises.
If the BoE decides to raise the base rate, your interest rate will typically rise by the same amount. As a result, you may end up with higher monthly repayments.
Tracker-rates can make it harder to budget accurately
Tracker-mortgages can make it harder to budget if you don’t know exactly what your repayments will be from month to month.
If you’re a first-time buyer, or you’re working to a tight budget, fluctuation in your mortgage payments could make it hard to plan. A rise in the base rate could make it more difficult for you to afford your mortgage payments.
If certainty and consistency is a priority for you, a tracker-rate may not be the best choice.
Some tracker mortgages have a “collar” or a rate which they won’t fall below.
There are some tracker-rate mortgages that have a lower-limit collar. This collar means that, even if the BoE cuts the base rate, you may not benefit from a reduction in your repayments.
A tracker-rate mortgage could be right for you – but it depends on your circumstances
Tracker-rate mortgages can potentially offer you lower monthly repayments than other deals, especially if the base rate is low or falls when you take out the loan. They can also offer greater flexibility if the product you choose doesn’t have early repayment charges.
However, if the base rate is high or rises after you take out your mortgage, it could end up costing you more in the long run. Also, the uncertainty that comes with changes in the base rate may make it an unsuitable choice for you.
A professional mortgage adviser can help you work out what’s best for you.
Get in touch
At NM Money, we can help you choose the right fixed, variable or tracker rate for you in your personal circumstances. Request a callback or call us on 03300 583 859 for more information.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.