Homeowners may be able to save hundreds of pounds by skipping popular fixed rate offers, credit experts have suggested. More than 1.4 million households are expected to see their borrowing costs rise this year as their current fixed-rate mortgage contracts expire.
Households could be asked to pay £250 more per month on average due to rising interest rates. Someone who entered into a two-year fixed rate agreement two years ago could have pocketed an interest rate of less than 2%. Today, these transactions are closer to 6%.
But some landlords could soften the blow by delaying signing a new fixed-rate deal. Variable rate mortgages, which have been considerably less popular for years, may now present a cheaper alternative.
Locked in: Homeowners can save hundreds of pounds by snubbing popular fixed rate offers, credit experts have suggested
What is a Variable Rate Mortgage?
Variable rate or tracker mortgages are loans where the interest rate increases or decreases according to the Bank of England base rate.
Some variable rate loans are not directly indexed to the base rate, so the lender has more flexibility to change them as they see fit. The downside is that borrowers with such mortgages can see their monthly costs increase 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 settle for two or five years. Until the end of last year, only about one in 20 new mortgages taken out involved variable rate transactions.
How much could you save each 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. Since the base rate is currently 3%, the interest rate is 3.26%. On a £300,000 mortgage over 25 years, the monthly payments would be £1,469.
In contrast, the two-year low fix is Virgin Money’s 4.6%. Monthly payments would be £1,690. Over a year, a homeowner would save £2,663 with the follow-on mortgage – if interest rates stay the same.
But what if the base rate goes up?
The Bank of England has raised its key rate rapidly in recent months and is expected to do so again in its next decision on Thursday. Forecasters predict that rates could rise by a quarter or half a percentage point to 3.25 or 3.5%.
The Bank raises its rates to try to contain inflation. If inflation doesn’t start to come down quickly, it could raise the base rate even further. But there’s enough of a gap between the best tracker and fixed rate mortgage offers that trackers may end up being cheaper even if the base rate goes up significantly.
In the example above, the trailing deal would only become more expensive than the fixed rate once the base rate hits 4.5%. In this case the monthly payments would be £29 more per month on the variable than on the fixed rate deal.
You can switch if you see a better fixed rate offer
The mortgage market is changing rapidly and fixed rate offers could soon become more competitive again.
Indeed, lenders such as Santander, Barclays, Halifax and Nationwide have cut their fixed rate offers in recent days. The other advantage of variable rate mortgages over fixed rate offerings is that they don’t tend to come with prepayment charges.
So if you sign up for a tracker and then spot a competitive fixed rate deal that you’re happy to close, you can always switch.
How popular are they now?
For years, the vast majority of homeowners have taken out fixed rate mortgages. Rates were rock bottom and borrowers were happy to commit. But that changed last year.
“The spike in fixed rates in the wake of the mini-budget has borrowers wondering if their first instinct to fix was necessarily the right one,” says David Hollingworth, managing partner at mortgage broker L&C.
“The jump in fixed rates has led to a resurgence in the adoption of variable rates. We saw follow rates go from a niche level of adoption to 30% of requests in November after the mini-budget. This has eased a bit since then and fixed rates have improved. But about one in five are still in the process of taking out a follow-on mortgage.
What future for interest rates?
Forecasting interest rates is difficult at the best of times. With the economic uncertainty we are experiencing, this is particularly difficult.
The Bank of England says it expects inflation to fall sharply from the middle of this year. If it is correct, it will have less reason to raise interest rates much more. Meanwhile, the financial markets anticipate an upcoming drop in interest rates below 4%.
“Lower inflation should mean that interest rates are stabilizing and even starting to fall,” says Karen Noye, mortgage expert at Quilter.
This could lead to mortgage rates falling to 4% 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 having trouble?
Some borrowers may find that they cannot afford their monthly mortgage payments even though they opt for a competitive deal. If you are having difficulty, you should contact your lender as soon as possible.
They may be able to help you, for example, by reducing the amount you pay for a short time, giving you a break, or allowing you to reduce monthly payments by extending the term of the mortgage.
You can also get help from Citizens Advice, which offers help for people in debt.
Go to citizenadvice.org.uk or call 0800 144 8848.
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