UK tracker mortgages explained; A complete guide
Tracker-rate mortgages; A simple definition
Tracker mortgages generally follow the Bank of England Base Rate (BOE Rate) with a set margin on top.
This means that every time the BOE rate changes your mortgage rate will alter by the same percentage within 30 days (on most products) and your monthly payments will go up or down accordingly.
For example, if the BOE rate was 0.5% and the given tracker deal was advertised as 2.75% then it would have a margin of 2.25%. If the BOE rate then increased to 1% your mortgage rate would go up to 3.25%.
This means they are riskier than fixed-rate mortgages during the initial deal, but perhaps less risky than discount and variable rates as the lender does not ultimately control changes to the rate.
If interest rates drop though, you have the benefit of seeing a drop in your payments and borrowing costs.
Tracker-rates will usually be offered at a lower rate than a fixed rate at the same point.
They are also usually available with either a 1, 2 or 3-year or lifetime tracker period. This is the length of time the deal tracks the BOE Rate and after which, it normally switches to a variable rate (lifetime trackers never revert to a different rate).
It is important to be aware that some lenders might base their tracker products around their base rate not the Bank of England's, this gives them room to change the rate legally without the BOE rate changing.
UK tracker-rate graph
Tracker-rates; How they work
In the chart above we see the behaviour of tracker rates compared to the Bank of England Base Rate (BOE Rate) and fixed rates.
In this example, the BOE Rate is 1% and the customer has a tracker deal with a margin of 0.5% giving them a “pay rate” of 1.5%.
In February the BOE rate increases to 2% and a month later the customer's tracker rate increases in line with it to 2.5%. This increases the customer's payments.
You can see that every time the BOE rate changes, the customer's tracker product changes by the same amount a month later.
By comparison, the fixed-rate mortgage doesn’t alter at all up or down during the fixed-rate period. No matter what happens to other interest rates, the fixed mortgage stays the same until it’s fixed period ends (it usually then “reverts” to either a tracker or variable rate).
So the fixed rate customers payments would not have altered at all whilst the tracker rate customer would have seen several fluctuations.
Tracker Mortgages; Who should take these deals?
Tracker rates are essentially the lowest risk products that are not fixed.
They have the potential benefit of being able to go down if interest rates decrease benefitting the customer with lower payments but come with the equal risk of going up in the other direction.
They are lower risk than variable and discount rates in general because the lender cannot simply change the rate to suit their needs (apart from the examples mentioned above).
They are considerably lower risk than LIBOR linked rates, although these are usually only offered on very specialist mortgage products for buy to let properties or people with “adverse” credit.
Most trackers will have some form of early repayment charges during the first few years.
This means they are generally best for someone who believes that interest rates are likely to fall or at the very least not increase by enough over the deal period to make it worth paying more for a fixed rate product.
But you need to be able to justify and afford the risk that rates and payments increase, as there are no upper limits on a normal tracker product.
So costs could increase significantly if you make the wrong assumption about the future.
Because the rate is not ultimately controlled by the lender though, they could be a better choice where you feel there is a risk of market turmoil.
For example issues like Brexit could cause unexpected pressures on banks that result in discount and variable rates being more likely to face increases than the BOE rate.
This could happen where global interbank lending rates increase whilst the BOE rate remains low (as happened during the credit crunch).
As they tend to have repayment charges initially it’s also likely that they would be less suitable for anyone who may have a desire to move home, sell the property or make very large overpayments during the first few years.
Customers who would need the flexibility to sell or pay off the mortgage in the short term without penalty may find better variable rate deals.
Although some trackers are available with no repayment charges particularly at lower loan to values.
Lifetime trackers can also be very good options for people in the later years of a mortgage.
As a mortgage balance reduces there comes a point where small differences in interest rates can be outweighed by the repeated costs of changing products every few years.
This means a lifetime tracker could be a good choice for those who only have a few years remaining on a mortgage and a relatively low balance, although this is case-specific and depends on the product rates available.
The tracker-rate questionnaire; Are they right for you?
So if you're considering a tracker-rate mortgage then the more of the following questions you would answer yes to, the more likely they are appropriate for you.
- Do you think the Bank of England Base Rate over the next few years is likely to remain low and stable or even decrease?
- Would you be happy paying more than a discount or variable deal to get a more moderate level of rate security?
- Is the difference in cost between the best tracker deals you can get and fixed rates enough to warrant taking the risk of increases?
- Could you afford increases to payments in the short to medium term and deal with budgeting for monthly changes in your payments?
- Are you open to taking risks but prefer to take a more middle-ground approach to risk?
- Is it unlikely you would be looking to move property during the tracker period, or make very large overpayments (for example significantly more than 10% of the balance in a single year)?
- Is it unlikely you would be looking to raise large amounts of additional borrowing from the property for any reason during the tracker period?
When are tracker deals a bad idea?
Tracker products are a bad idea when you need very strong security of payments and the ability to budget.
If there is a very small cost benefit over fixed rates and you are unsure of the likely direction of interest rates they are generally a bad idea unless you are happy with the risk of paying more than you need to.
If you believe interest rates are likely to rise during the tracker period by more than the difference to available fixed rates then they are also likely to be a poor choice in most cases, or if you feel it is very likely that inflation will be high over that period.
If you feel interest rates should be declining during the deal a discount or variable may be even cheaper and also if you feel inflation should be very low.