What is a Variable Rate Mortgage?

June 18, 2024

52
A variable rate mortgage is a type of home loan where the interest rate can change periodically, based on an underlying benchmark interest rate or index that fluctuates. This means that your mortgage payments can go up or down over the life of the loan. Here’s an in-depth look at how variable rate mortgages work and what you need to know:

Key Features of a Variable Rate Mortgage

Interest Rate Fluctuations

    • Linked to Benchmarks: The interest rate on a variable rate mortgage is usually tied to a benchmark interest rate, such as the Bank of England base rate or the lender’s standard variable rate (SVR). Changes in these benchmarks directly affect your mortgage rate​ ​​ ​.
    • Periodic Adjustments: The rate can adjust at predetermined intervals (e.g., annually, semi-annually) depending on the terms of your mortgage.

Initial Period and Later Adjustments

    • Initial Rate: Often, variable rate mortgages offer an initial period with a lower, fixed interest rate. After this period, the rate adjusts to reflect changes in the benchmark rate.
    • Subsequent Changes: After the initial period, the interest rate can increase or decrease, which will affect your monthly mortgage payments.

Types of Variable Rate Mortgages

    • Standard Variable Rate (SVR): This is the default interest rate that lenders apply to mortgages after any initial fixed or discounted rate period ends. The SVR can change at any time, usually in response to changes in the Bank of England base rate.
    • Tracker Mortgages: These track a specific benchmark rate, such as the Bank of England base rate, plus a set percentage. If the base rate increases or decreases, the tracker rate moves correspondingly.
    • Discount Variable Rate Mortgages: These offer a discount off the lender’s SVR for a certain period. The actual interest rate paid can still vary as the SVR changes.

Benefits of Variable Rate Mortgages

Potential for Lower Payments

    • Initial Low Rates: Often, variable rate mortgages start with lower rates compared to fixed-rate mortgages, which can result in lower initial payments​ .
    • Falling Rates: If interest rates decrease, your mortgage payments will also decrease, which can save you money.

Flexibility

    • No Early Repayment Charges: Some variable rate mortgages come with no early repayment charges, giving you the flexibility to overpay or pay off your mortgage early without penalties​ ​.

Risks and Considerations

Payment Uncertainty

    • Rising Rates: If interest rates rise, your monthly mortgage payments will increase, which can strain your budget.
    • Budgeting Challenges: The variability of payments can make long-term financial planning more challenging.

Economic Factors

    • Economic Influence: Changes in the broader economy, such as inflation and monetary policy decisions by the Bank of England, can significantly impact your mortgage rate and payments.

Example Scenario

Let’s say you have a tracker mortgage set at the Bank of England base rate + 1%. If the base rate is 0.5%, your mortgage rate will be 1.5%. If the base rate increases to 1%, your mortgage rate will rise to 2%, increasing your monthly payments accordingly.

Conclusion

A variable rate mortgage can offer initial savings and flexibility but comes with the risk of fluctuating payments. Understanding how these mortgages work and the factors that influence interest rates is crucial for making an informed decision. Consulting with a mortgage adviser can help determine if a variable rate mortgage suits your financial situation and risk tolerance.

Answered by:

Alison Gibson

Mortgage and Protection Adviser

Last Updated:

19.06.2024

Answered by:

Alison Gibson

Mortgage and Protection Adviser

Last Updated:

19.06.2024

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