If you're looking for a mortgage you've probably looked at the pros and cons of fixed- and variable-rate deals. But, have you considered the various different types of variable-rate mortgage that are available? Variable-rate mortgages typically come in two types: tracker rates and discounted variable rates. To help you work out which type of deal might be best for you, we've put together this simple guide.
Tracker mortgage rates are designed to follow a certain central interest rate. Most tracker rate deals follow the Bank of England base rate, although some follow other rates such as the London Interbank Offered Rate (LIBOR).
Quite simply, a tracker rate mortgage will go up and down as the underlying rate changes. For example, if you currently have a tracker rate at 2% over the Bank of England base rate, your mortgage rate will be 2.5%, as the base rate is 0.5%. If the base rate rose to 1%, your mortgage rate would rise to 3%. Many people like tracker rates as they are transparent and you know exactly what you will pay.
A discounted variable rate works in a similar way to a tracker rate but there is one crucial difference. Instead of your mortgage rate being linked to a central interest rate, it is linked to the standard variable rate (SVR) of your mortgage lender.
While lenders' SVRs tend to move up and down in line with the base rate, your lender can change their SVR whenever they want to. As we reported recently, several lenders have recently increased their SVR despite the base rate remaining the same.
So, if you choose a discounted variable rate you could see your payments rise and fall even if underlying interest rates don't change. Your lender may also choose to raise their SVR by more than any increase to the base rate.
There are pros and cons to both types of deal. Tracker mortgages have become more popular in recent years because they are directly linked to the base rate. This means you won't end up paying more than you should if your lender raises its SVR by more than any increase to the base rate. Recent rises to SVRs have resulted in increased payments for borrowers on discounted rate mortgages even though the base rate hasn't changed. Borrowers on tracker rate deals aren't affected.
However, the reverse situation might benefit discounted rate borrowers. Keith Osborne from whathouse.co.uk explains: "Lenders sometimes don't increase their SVR by the same amount as any base rate increase. When the base rate ultimately starts rising, you may find that your lender doesn't pass on this increase in full. In that situation you would actually be better off on a discounted variable rate than on a tracker mortgage."