UK Variable mortgages explained - A complete guide
Variable rate mortgages - A simple definition
A variable rate mortgage is just a rate the lender sets as and when they choose, meaning they can change it at any time usually by any amount.
If the rate went up so would your payments and vice versa. Therefore, they are very similar really to discount rate mortgages as well.
Variable rates tend to be lifetime products. This means you can sit on this deal if it suits you for the whole term of the mortgage whether that is 15, 25, 30 years, or something in-between.
Variable rate products often also have no repayment penalties meaning you can overpay by any amount and at any time.
As the lender chooses when and how to adjust the rate this means they have some extra risk versus tracker mortgages where the lender has no control over the setting of the rate once the mortgage starts, and much more risk versus a fixed rate.
UK variable rate graph
Variable rates – How they work
In the chart above we see the behaviour of variable rate deals compared to the Bank of England Base Rate (BOE Rate) and a fixed rate.
You can see that the variable rate mortgage tends to follow the Bank of England base rate to a large extent.
When the BOE rate increases or decreases the variable rate is likely to follow suit shortly after, and this would either increase or decrease your payments accordingly.
In September you see the BOE rate go down, but the variable rate hasn’t changed. This illustrates that the variable is set by the lender, and they only pass on changes to the BOE rate if they choose too although they often will.
This also means they could put the rate up at any time by any amount too.
You can also see that a fixed rate mortgage would not change at all, regardless of the changes in variable or BOE rates until the end of the fixed period.
A fixed rate would normally switch to a variable once the fixed deal ended.
Because variable rates are usually lifetime products it never changes back to a higher “reversion rate” but simply carries on generally following the BOE rate as long as the customer keeps the deal.
Variable Mortgages - Who should take these deals?
Variable rates tend to be the cheapest available deals with little or no redemption penalties and that run for the lifetime of the mortgage (i.e. the total number of years the mortgage has been arranged over not just the initial deal in the first few years).
This makes them good for people who may need the flexibility of paying large amounts off in the short term or who may be moving house for example, or that want a deal which they can keep long term and not have the hassle of having to change regularly.
But these mortgages along with discount rates have potentially the greatest risk of most normal mortgage products and so it’s important they aren’t chosen just because they seem cheap.
They can work out very favourably for people in the autumn of their mortgage.
As a mortgage gets down to the final 5-10 years of its term the continually reducing balance limits the financial benefit of changing regularly to get better rates, and the associated costs involved, as well as meaning that increases in rates are potentially less concerning.
But it should also be remembered that a long term fixed rate could serve equally well so the question remains on whether the expectation is for interest rates to rise long term in which case a long term fix may be better.
The variable rate questionnaire – Are they for you?
So if you're considering a variable rate mortgage then the more of the following questions you would answer yes to, the more likely they are appropriate for you.
- Are you not particularly concerned about the risk of rising interest rates in the longer term?
- Could you afford significant changes in rates without too much difficulty?
- Do you want to hedge your bets by taking a cheap deal now with the option to switch to a fixed later without being penalised if rates rise quickly?
- Do you feel interest rates are unlikely to rise significantly in the medium to longer term?
- Are you coming towards the later years of your mortgage when the balance is very low?
- Are you wanting to get the cheapest possible long term deal?
- Are you likely to be moving home in the next few years, making large overpayments (well in excess of 10% of the balance in a year) or looking to raise money out of the property once works are complete for example?
- Would you prefer to avoid having to re-organise the mortgage frequently?
The important thing when looking at variable rates is about the balance of requirements.
If you might just want to pay your mortgage off in a couple of years, there could be plenty of other deals with less risk that might be better.
Similarly, if you just want a cheap product, discounts could often be cheaper and fixed rates in particular the shorter term ones could have very little different in price at present.
If there is no real need for some of the flexible aspects of these products, then it’s quite likely that they could end up being more expensive.
So as ever it’s really important to take advice from a whole of market broker like ourselves who can help you actually weigh up what is right for you as the costs of making poor decisions can be significant.
When are variable deals a bad idea?
Obviously a variable rate is a terrible idea in a market where you feel rates will rise sharply and quickly upwards unless you have an overwhelming need for a deal with some of the other benefits of variables like having little or no redemption penalty.
It’s usually pretty difficult to really judge this though.
So in the real world they work well for someone who has a real need for either the benefits of a lifetime deal, or no repayment charges or for those who want to hedge their bets a little and have the option to switch to a fixed deal cheaply if the market turns and rates start rising a lot.
It’s also important to note the major risk of these deals being they have no upper limit in cost. During the credit crunch we saw many lenders put their variable rates up, despite the BOE rate having dropped from around 5 to 0.5%.
This is especially a risk with specialist lenders offering buy to let mortgages, or those for unusual properties or clients with poor credit history, but even the major banks have not passed on most of the reduction in costs.
This means in general that anyone who is very concerned about increases in borrowing costs, who needs certainty of their payments, and has no need for the more flexible benefits a variable has should really be considering at least a tracker mortgage but more likely a fixed rate.
Again though, always take advice before you make your mind up.