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Variable rate mortgage - Is it the best option for you?

By Edited Jan 10, 2014 1 2

Variable rate mortgage explained

Broadly speaking a variable rate mortgage is one where the interest charge changes, depending on the market interest rates. There are two types of variable interest mortgages available;

Fixed variable rate mortgage

A fixed variable mortgage tracks the bank’s base interest level and will follow its movements and fluctuations throughout the term of the funding deal. So, let’s say you have a fixed variable rate mortgage carrying 1.5% interest. This means the mortgage interest rate is 1.5% above the base rate at all times. So, if the bank’s base rate is 2.5% at the time the mortgage is taken out the mortgage interest rate will be 4.0%. If the base interest falls to 1.0% the mortgage interest rate will also fall, but only to 2.5%. Similarly, if the base interest increases to 4.0% the mortgage interest rate will also increase but to 5.5%.

When a borrower has this kind of mortgage the lender is legally obliged follow the base interest rate, even if it means the lender is going to lose out, as is the case when the base interest falls. Since you have no control over the bank’s base rate taking out a this type of mortgage can be quite risky and expensive, especially if the base rate is increased. However, if you are comfortable the base rate has peaked and will only go down this type of mortgage may end up saving you an awful lot of money.

Over the last few years base rates have been at an all time low and those people who took the risk and had a fixed variable rate mortgage before the base rate went through the floor have done very well. These mortgages are only available for a specific amount of time and most of these mortgages have now expired so the savings have dried up a bit. Most fixed variable rate mortgages have been withdrawn from the market and it is now become difficult to get one because the base rate is so low. When the fixed variable rate mortgage comes to the end of the term is transfers over to the second type of variable rate mortgage, which is the standard variable rate mortgage.

Standard variable rate mortgage

The standard variable rate mortgage works much in the same way as the fixed variable rate mortgage, however there are some differences. A standard variable rate mortgage broadly tracks the bank’s base rate although the mortgage lenders are not obliged to pass on any savings to the borrower when the base rate falls.

When your current mortgage deal reaches the end of its term it will automatically transfer over to a variable rate mortgage and since this is often the most expensive mortgage on the market you are advised to shop around and find a more affordable mortgage deal.

Advantages of a variable rate mortgage

The main advantage of this type of mortgage is that if you can get the right mortgage deal at the right time you could end up saving a lot of money over other types of mortgage.

The disadvantages of a variable rate mortgage

Since you have no control over the base rate, and this affects the variable rate mortgage, it is difficult to budget when you have this type of mortgage. If you can comfortably make the mortgage repayments this should not create any problems, however if you are highly leveraged and can only just make your monthly repayment this could be a bit more problematic.

With a variable rate mortgage you are totally at the mercy of the bank’s base rate and if the base rate increases your interest rate increases, which could result in higher monthly payments.

Is a variable rate mortgage worth signing up to?

Is a variable rate mortgage worth signing up to? The answer to this depends entirely on the individual and personal circumstances. Some people like certainty and want to know how much their monthly mortgage payment is going to be. Neither a fixed nor standard variable rate mortgage allows for this, therefore a variable rate mortgage is not going to be the best option. In these circumstances the borrower is best of with a fixed interest mortgage, which provides some certainty. If the borrower thinks the base rate is going to decrease, and is willing to take a bit of a risk, the fixed variable rate mortgage is well worth signing up to and there are savings to be made if the risk pays off.

Fixed variable ortgages will only last for a finite period, which is going to be a few short years, so even if your decision to take out a variable mortgage turns out to be the wrong one you won’t have to suffer it for too long. Alternatively, you may can buy your way out of it although the penalties are going to be severe.

The standard variable rate mortgage is one that needs to be treated with a bit of care and if you find yourself on one of these you need to closely monitor the situation. The standard variable mortgage is considered to be the most expensive in the market however this is not always the case. If you have little equity in your home the standard variable rate mortgage may end up being the most affordable mortgage for you.

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Comments

Nov 15, 2011 5:11pm
Deborah-Diane
Great advice about treating variable rate mortgages with a bit of care. I am a former Realtor, and have seen people get hurt by them. Great article.
Nov 16, 2011 5:31pm
Ddraig
Very good article Yackers. I fix my mortgage each time it comes around. Least it is safe that way, although I could be paying 3 % lower at the moment, it usually saves me over the 5 year period.
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