Variable Rate Mortgages

Variable-rate mortgages are often known as the alternative to fixed-rate products, however, there is less understanding around the different types of variable rate deal available. While all variable rate deals have one thing in common, there are also key differences that it’s important to understand before selecting the right type of deal for you.

We look at the different types of variable rate mortgage deals, how they each work, and how to decide which type, if any, is suitable for your needs. If you need more support once you’ve read through, feel free to reach out to any of our knowledgeable advisers.

What is a variable rate mortgage?

Variable rate applies to the type of interest rate on your mortgage. Unlike fixed-rate deals, where the interest rate remains static for the deal term, with a variable rate, it can both increase or decrease at any time.

While you can get set deal terms (sometimes referred to as the introductory period), much like with a fixed deal, for example, a 5 year tracker deal, the interest rate quoted when you take out the deal can change at any point during that 5 year period.

Due to the lack of certainty with your interest rates, your repayments can fluctuate from month to month. While this is offputting to some, others prefer the flexibility offered by variable rate deals. Often, the rate at the beginning of the deal is lower than that of an equivalent fixed-rate deal due to the lack of guarantee, which can also be appealing.

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How variable rate mortgages work

While the two main types of mortgage interest rate are fixed-rate and variable rate, the latter actually splits off into 4 distinct categories. Each of these variable rate mortgages are referred to differently, and also work differently to each other.

While all variable rate mortgages have one thing in common: the fact that the interest rate can change at any time (hence it’s variable), that’s pretty much where the similarities end in terms of how they function.

Types of variable rate mortgage

We have broken down the main types of variable rate mortgage below...

Tracker mortgages

Tracker mortgages are set based on an external financial indicator, most commonly, the Bank of England (BoE) base rate. This is what most people think of when they hear the term variable rate. It tends to be popular as they increase or decrease based on a decision made outside of the lender’s control, which borrowers often find gives it greater neutrality.

However, the individual mortgage lender sets the percentage their tracker rate sits above the base rate (or whatever economic benchmark they use). For example...

A product advertised as BoE Base Rate + 1.25%

• If the base rate is 4.25% - this element is only changeable by the bank of England

• 1.25% - is set by the lender, for the length of your deal term

• So your actual rate at the outset is 5.50%

• However, while the 1.25% above the base rate cannot change, the base rate can rise or fall up to 8 times in the average year, based on decisions made by the bank of England

• If the base rate rose by 0.5%, your rate would rise to 6%, if it fell by 0.5%, your rate would fall to 5%. These changes typically come into effect 14-30 days after the announcement is made, or on the 1st day of the following month

Once your deal term has ended, you would automatically be transferred to your lender’s SVR, which is typically higher. You could also choose to remortgage to a new tracker deal, but there would be no guarantee that the next deal is the same amount above the base rate as your last.

While flexible, many introductory tracker deals carry strict early repayment charges (ERCs) if you try to switch lenders before the deal term ends.

Standard variable rate (SVR) mortgages

A Standard Variable Rate (SVR) mortgage is essentially the only type of mortgage that isn’t a specific deal type. It’s what the lender sets as their baseline interest rate, and is usually substantially higher (often 2-4% more) than any of the fixed or variable rate deals that they offer.

This rate is entirely decided by the lender, and while changes in the base rate might influence their decision, they are not obligated to follow its direction. SVRs are typically avoided by most borrowers, given their expense, and they are known as the rate you revert to automatically when your deal term ends.

That said, there are some distinct advantages to SVRs that rarely apply to fixed-rate or other variable rate deals:

• They allow unlimited overpayments, there is no limit on what you can repay on your mortgage and when

• You are not tied into them as they are not a deal. This means you can leave at any time without paying a fee

• Their flexibility means that SVRs can be helpful for those who intend to move home in the near future, for example

Discount rate mortgages

A discounted rate mortgage is set in a similar way to a tracker mortgage, but rather than being a set amount above the BOS base rate, it’s a set amount below the lender’s own standard variable rate. For example:

A lender has an SVR of 7.25%

• Their discount rate is set at 2.0% below this

• Your initial rate is therefore 5.25%

• However, the lender can raise their SVR at any time

• If they increased the SVR by 0.5% your discount would remain 2% below that, but your interest rate would rise to 5.75% (7.75%-2%) and vice versa if they lowered it

While lenders may not necessarily change their SVR as often as an external indicator, there is always the potential for this to happen as often as they like. This could mean your mortgage repayment fluctuates every month, and while it could go down as well as up, this can be offputting for those on a tight budget.

Caps and collars on variable rate mortgages

Capped and collar rates are not really a specific type of mortgage, but additional clauses on other variable rate mortgages, such as tracker and discount deals:

caps can be found on trackers or discount mortgages. They are not incredibly common, but are highly favoured, as they set some level of balance between a fixed and a variable rate.

A cap (or ceiling) applied to a rate is an absolute legal limit above which your interest rate cannot rise. For example:

You have a 5% tracker rate with a cap of 6.5%

• The base rate of interest rises by 2% over a series of decisions (it rarely rises in increments of more than 0.5% at a time, but can in certain circumstances)

• You rate also rises, but once you hit 6.5% your interest rate cannot go any higher for the length of your deal

This is a highly sought after product, as if the base rate (or SVR) falls you benefit from a reduction in interest, but if it rises above a certain level, you know it won’t rise above the capped level.

Because of the considerable risk to lenders, capped rate mortgages are relatively rare in the UK at the moment. They also often have higher product fees and higher interest rates than noncapped products. However, these can be a great middle ground for those looking for flexibility, but not confident enough to weather high rate hikes.

Collars (or floors) are the opposite. Sadly these are much more common and should not be overlooked, as they could mean that a Tracker or discount deal is not as attractive as you first thought.

Most tracker mortgages actually have a collar, which means that if the Bank of England base rate drops below a certain level, your mortgage rate stops falling. While this is typically very low, such as 0.5%, meaning that you can’t be left paying 0% interest, should the base rate ever fall that low, it’s important to look out for high caps on this type of deal.

Compare variable rate mortgages online

To calculate how much you’d pay on current tracker rate deals, you can use our mortgage comparison tool below. It features the latest tracker deals from 90+ UK lenders, as well as their fixed rate deals so you can see how they compare to their variable equivalents.

Pros and cons

The exact advantages and disadvantages depend on the type of variable rate deal you choose, as well as your own personal circumstances. What seems to be an advantage for some applicants may be a disadvantage to others. It’s always best to speak to a mortgage broker if you’re unsure.

However, all variable rate mortgages, when compared to fixed rate mortgage deals, have some common pros and cons:

Available mortgage lenders

All lenders have at least one, although an SVR is not really a deal, as it’s their default rate. However, trackers and discount rates are also offered by a broad range of high street and specialist mortgage lenders, such as:

• Barclays - has highly competitive tracker products

• HSBC - offers tracker options with varying fee structures

• Nationwide Building Society - are known for consumer-friendly variable terms, often incorporating highly flexible overpayment clauses

• NatWest - offer a selection of tracker and other variable products tailored toward residential buyers and remortgage applicants

• Santander - has tracker options often tied directly to their standard current account perks, making them a popular choice for borrowers looking to consolidate their banking and borrowing

• Halifax - offers variable and discounted rate frameworks, frequently offering cash-back incentives for remortgagers

• Accord Mortgages - offer variable and offset mortgages, ideal for borrowers wanting to use their savings to reduce the interest charged on a variable rate

• Aldermore - has variable and discounted products which are offered with manual underwriting, often open to self-employed borrowers

• Kensington Mortgages - offer tracker and other variable options designed for individuals who might be rejected by the rigid criteria of the high street

• The Mortgage Works (TMW) - Ideal for landlords, they offer an extensive range of tracker and variable rate mortgages on buy-to-let mortgages

Why choose Money Helpdesk?

At Money Helpdesk, our whole-of-market advisers have access to variable deals and bespoke tracker mortgages across the entire market, some of which are not available to the general public.

We can assess your needs and recommend which variable rate type, and lender, offers the most suitable terms for your needs. Whether you’re a landlord looking to keep your outgoings to a minimum with an interest-only tracker, or you’re looking to remortgage but don’t want the burden of being tied in while the market is in flux, we’re here to help.

Ready to explore your options? Get started here for a free, no-obligation consultation with a mortgage adviser.