Why you're better off with a tracker mortgage

Despite a move towards fixed rates, a cheap and cheerful tracker could still save you money.

In uncertain times people look for security, an anchor to keep them steady in the prevailing storm, and the recession has certainly given many people the jitters.

Further public sector job cuts later in the year, and their impact on the economy, do little to ease these worries, so it’s little wonder that more people are putting safety ahead of price when it comes to their mortgage. Broker John Charcol noted that 26% of borrowers chose a fix in May, the highest level since last October.

But let’s face it, if you went on price alone, no one would take a fixed deal, even though lenders have slashed rates in the last two months. No, people are finally fixing because the difference in price between them and trackers has narrowed sufficiently for the safer option to look attractive. The tipping point has been passed for some borrowers, but many are not willing to pay the significant premium that still exists if you want to fix your rate.

Take a chance on a tracker

In fact, many people simply want to get the cheapest mortgage deal they can -- and why not? You get no prizes for paying interest to your mortgage lender.

According to financial information provider Moneyfacts the average fixed rate mortgage is 5% and the average tracker deal is 3.71%.

On a £150,000 mortgage the fixed rate would cost you £877 a month, which over a typical two-year deal would total £21,048.

And the tracker would cost £768 a month, totaling £18,432 over two years.

In other words, the tracker is £109 a month cheaper, costing £2,616 less over 2 years.

That’s a massive saving, and it would be more pronounced on larger mortgages. But what about the risk of rising interest rates? Surely borrowers are taking a huge chance by going with a variable rate mortgage?

Rate expectations

Of course, any variable rates, including trackers, are more high risk than a fixed rate because they have the potential to go up or down. And, let’s face it, down isn’t really an option with the Bank of England Base Rate at a record low of 0.5%!

Related blog post

• John Fitzsimons writes:

  Should you get a fixed rate or a tracker?

  With interest rates languishing at record lows, is now the time to take advantage with a tracker, or go for the safe option of a fixed rate?

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So if you take a tracker your pay rate could rise and you are beholden to the Bank of England’s Monetary Policy Committee, since your mortgage rate tracks Base Rate at a set margin.

The good news is that most economists now agree that Base Rate is likely to remain at its current level of 0.5% for at least the rest of this year. Beyond that opinion differs widely. Some have argued that rates could stay extremely low for the next five years, while others believe we will start to see sustained rises from next spring. That’s the chance you are taking with a tracker.

However, if you want to benefit from cheap monthly repayments now, there are some things you can do to minimise the impact of future rate rises:

1.    Overpay today

If you get a cheap tracker deal you are going to have more money in your pocket than if you go for a fixed rate.

It’s what you do with that cash that is key. Blowing it on fine wine and holidays is one option, or you could use it more wisely. You could save the surplus cash each month, giving you a nice little pot to dip into should your mortgage rate rise in the future. Or overpay your mortgage now while you can afford it. Not only will this reduce your debt more quickly, it will give you a buffer that could prove crucial if rates rise and you start to struggle.

Find out why overpaying makes financial sense in my recent article Slash years off your mortgage.

2.    Get a capped deal

A capped mortgage is variable -- it moves up and down in line with interest rates -- but it differs from a tracker because the lender puts a maximum cap on the mortgage that the pay rate can never rise above.

For example, Britannia Building Society currently offers a tracker at 2.99% (Base +2.49) that is also capped at 5.99%, so your pay rate will never go above that. In other words, you will track any rate increases up to 3.5%, but if Base Rate goes higher, your tracker will not.

Nationwide subsidiary The Mortgage Works also has a range of capped deals that are worth a look if you fancy having your cake and eating it.

3.    Go for a lifetime tracker

One of the concerns that some people have about taking a tracker deal is that many tie you in with Early Repayment Charges (ERCs). So on a two-year tracker for example it will cost you to switch to another deal within the first two years -- usually between 2% and 4% of your outstanding balance.

This means that if rates start rising rapidly you might want to flee to a fixed rate but you’ll face a hefty penalty to do so.

However, lifetime tracker deals, which track Base Rate for the term of the loan, usually come without any ERCs. If you want to switch after a year for example, you won’t usually be charged a penalty to get out of your current deal (unless you are with Woolwich, the exception that proves the rule).

A similar option is a drop-lock mortgage, where you take a standard tracker, but the lender agrees to waive any ERCs if you want to switch to one of its fixed rates at any time. Nationwide offers this, for example, calling the facility ‘Switch and Fix’.

If you fancy cutting your mortgage costs and are tempted by a tracker, here are some of my favourites:

18 best buy trackers

More: Beware the speculative property seller | Mortgage borrowers: Get off your SVR – quick!