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What Is a Variable Rate Mortgage?
When you approach your mortgage broker or lender for a home loan or new mortgage deal, you will have the option to choose either a variable-rate mortgage (VRM) or a fixed-rate mortgage (FRM).
Opting for a VRM will see your interest rate fluctuate as the mortgage rate increases and decreases. Therefore, for the duration of your mortgage term, your repayments will differ monthly.
The variable rate of your specific mortgage is set by your mortgage lender.
In comparison, a FRM will ensure your mortgage rate and monthly repayments stay fixed for the duration of your mortgage payment period.
In their initial phases, VRMs will start at a lower interest rate than fixed-rate deals.
How does a variable rate mortgage work?
Because your interest rate is not fixed, it will adjust at a set level determined by your lender.
Some VRM rates follow the Bank of England (BOE) base rate, while others can fluctuate regardless of the base rate movements.
What is important is that the interest rates of VRMs will continually fluctuate during their term, pushing your monthly instalments up or down.
What Are the Different Variable-Rate Mortgages in the UK?
UK banks can generally offer three different VRMs:
- Standard variable rate (SVR) mortgages: FRM deals are migrated to your lender’s standard variable rate at the end of their terms. Each lender sets its own SVR. According to The Times UK, the average SVR in October 2023 stood at 8.18%.
- Tracker mortgages: As the name suggests, these mortgages track the BOE base rate. They are offered at the base rate with an added set percentage.
- Discount variable rate (DVR) mortgages: Mortgage lenders offer this incentive rate to their borrowers to attract clients. It is usually set at a specific percentage point below their individual SVRs.
To choose the rate that best suits your personal circumstances, speak to your lender about how these varying rates can affect your monthly mortgage payments and budget.
Advantages and Disadvantages of VRMs
Pros
- Affordable mortgage repayments: When interest rates fall to a particularly low level, your repayments decrease, making them more affordable than FRM deals.
- Lower initial payments: In comparison to fixed-rate mortgages, VRMs generally offer more affordable and lower repayments at the start of their term.
- Lower arrangement fees: These deals generally have lower arrangement fees than tracker deals or fixed-rate deals.
- No early repayment charges (ERCs) and penalties: If you decide to migrate to a different mortgage deal or pay off your mortgage, you generally will not be liable for penalties.
- Overpayments: Many variable-rate deals allow you to pay more than your minimum monthly instalments to help you save on interest costs and pay off your mortgage faster.
Disadvantages
- Constantly changing repayments: Because of their variable nature, these mortgages make budgeting challenging. As interest rates rise or fall during your mortgage term, so too will your payments, making it difficult to budget for your repayments in advance.
- High repayments at times: If the mortgage rate reaches excessively high levels, your payments are also going to increase substantially.
- Generally more expensive than other mortgages. Though the initial repayments may be more affordable, VRMs could work out more expensive in the long run. For example, when the mortgage rate reaches high levels, for long periods, clients with FRMs will pay a lot less than those with VRMs.
- Capped or collared rates: Some lenders have caps on how low your variable rate instalments can go. So, even if the interest rate falls to 0%, the caps would keep your repayments at a specific level.
Choosing Your Variable-Rate Mortgage
Consider the following factors when selecting your VRM:
- Financial situation: Speak to your broker to see how much your selected mortgage rate can fluctuate over your mortgage period and how this might affect your payments. Opt for a mortgage with a variable rate that will result in the least amount of drastic increases in your repayments.
- Risk tolerance: Choose a repayment plan based on your risk appetite. A tracker mortgage works best for those who don’t mind a bit of risk and constantly changing repayments. A DVR mortgage will work better for those with a low appetite for risk and allow more long-term stability.
- Future plans: VRMs are perfect for buyers who plan to move or buy another home in the short term. They usually do not have any ERCs and penalties and allow you to pay off your mortgage or sell your home.
FAQs
What happens at the end of my variable-rate agreement?
When your current deal ends, your mortgage will move to your lender’s SVR. If the SVR is lower than your existing rate, your instalments will decrease, helping you save money. If the SVR is higher than your current rate, your repayments will increase.
What are the alternatives to taking a variable-rate mortgage?
If a VRM deal is not your cup of tea, consider these other mortgage options:
- FRMs – offer clients fixed mortgage repayments for the duration of their mortgage payment term and can protect them against potential fluctuations in mortgage rates.
- Capped-rate mortgages – these mortgages have a limit on the interest you are charged on your repayments and ensure your payments never go above a certain amount.
- Discount mortgages – offer repayments at interest rates lower than your broker’s SVR (for the duration of your mortgage period).
Sources:
https://www.marimarkmortgage.com/blog/mortgage/pros-cons-variable-rate-mortgage
https://restless.co.uk/mortgages/mortgage-basics/should-i-go-for-a-fixed-or-variable-rate-mortgage/
https://www.landc.co.uk/mortgage-guides/variable-rate-mortgage/
https://www.landc.co.uk/mortgage-guides/variable-rate-mortgage/