Homeowners fixing this year should consider a variable rate

Homeowners may be able to save hundreds of pounds by snubbing popular fixed-rate deals, lending experts have suggested. 

More than 1.4 million households are set to see their borrowing costs surge this year as their current fixed rate mortgage deals expire.

Households could be asked to pay an extra £250 a month on average due to rising interest rates. Someone who took out a two-year, fixed-rate deal two years ago could have bagged a rate of less than 2 per cent interest. Today, those deals are closer to 6 per cent. 

But some homeowners could soften the blow by delaying signing up to a new fixed-rate deal. Variable rate mortgages, which have been considerably less popular for years, may now present a cheaper alternative.

What is a variable rate mortgage?

Variable rate or tracker mortgages are loans with an interest rate that rises or falls in step with the Bank of England base rate.

Some variable rate loans are not directly pegged to the base rate, so the lender has more flexibility to change them as it chooses. The downside is that borrowers with such mortgages can see their monthly costs rise with little or no notice.

Such uncertainty means variable rate mortgages tend to be far less popular than fixed-rate deals, which guarantee payments will stay the same. Households tend to fix for two or five years. Until late last year, only about one in 20 new mortgages taken out were for variable rate deals.

How much could you save every month?

The cheapest tracker mortgage is currently 0.26 percentage points above the base rate and is offered by Barclays, according to mortgage broker L&C. As the base rate is 3 per cent at the moment, the interest rate comes out at 3.26 per cent. On a £300,000, 25-year mortgage, monthly payments would be £1,469.

In contrast, the lowest two-year fix is 4.6 per cent from Virgin Money. Monthly payments would be £1,690. Over a year, a homeowner would save £2,663 with the tracker mortgage – if interest rates stay the same.

But What if the base rate rises?

The Bank of England has been raising the base rate rapidly in recent months, and is likely to do so again when it makes its next decision on Thursday. Forecasters predict rates could rise by a quarter or half a percentage point to 3.25 or 3.5 per cent.

The Bank raises rates to try to keep inflation in check. If inflation doesn’t start to fall soon, it may increase the base rate further. But there is a sufficient gap between the best tracker and fixed-rate mortgage deals that trackers may end up cheaper even if the base rate rises significantly.

In the example above, the tracker deal would only get more expensive than the fixed rate once the base rate rose to 4.5 per cent. In that case, monthly payments would be £29 a month more on the variable than on the fixed-rate deal.

You can switch if you see a better fixed-rate deal

The mortgage market moves quickly and fixed-rate deals may soon become more competitive once again.

Indeed, lenders including Santander, Barclays, Halifax and Nationwide have cut their fixed-rate deals in recent days. The other advantage of variable rate mortgages over fixed-rate deals is that they don’t tend to come with early repayment charges.

So, if you sign up to a tracker and then spot a competitive fixed-rate deal that you are happy to lock into, you can always switch.

How popular are they now?

For years, the vast majority of homeowners took out fixed-rate mortgages. Rates were at rock bottom and borrowers were happy to lock in. But this changed last year.

‘The rocketing fixed rates following the mini-Budget saw borrowers reconsider if their first instinct to fix was necessarily the right one,’ says David Hollingworth, associate director at mortgage broker L&C.

‘The leap in fixed rates saw a resurgence in the take-up of variable rates. We saw tracker rates increase from a niche level of uptake to as much as 30 per cent of applications in November following the mini-Budget. That has eased a little since then and fixed rates have improved. But about one in five is still out taking a tracker mortgage.’

So what next for interest rates?

Forecasting interest rates is difficult at the best of times. With the economic uncertainty we are experiencing, it is especially tough.

The Bank of England says it expects inflation to fall sharply from the middle of this year. If correct, it will have less reason to raise interest rates much further. Meanwhile, financial markets are pricing in interest rates dropping below 4 per cent soon.

‘Lower inflation should mean interest rates stabilise and even start to drop,’ says Karen Noye, mortgage expert at Quilter.

This could result in mortgage rates dropping to 4 per cent by the end of the year and potentially even lower in the future, which will have a real impact on monthly mortgage costs.’

What if you’re struggling?

Some borrowers may find that they cannot afford their monthly mortgage payments even if they opt for a competitive deal. If you are struggling, you should contact your lender as soon as possible.

It may be able to help you by, for example, reducing the amount you pay for a short period of time, giving you a break or allowing you to cut monthly payments by extending the mortgage term.

You can also get help from Citizens Advice, which offers help to those in debt.

Go to citizensadvice.org.uk or phone 0800 144 8848.