Fixed-rate mortgage or tracker? How to tackle rising interest rates
Mortgage borrowers are faced with a dilemma: fix their home loans or hold out on increasingly expensive “tracker” mortgages until rates reduce further.
The Bank of England increased interest rates by 0.25 percentage points to 4.5pc earlier this month as it scrambles to control inflation which, despite falling, was still at 8.7pc in March according to new data published today.
More worrying, so-called core inflation rose to 6.8pc, the highest level since 1992, amid fears domestic inflation is out of control. This could encourage the Bank to keep increasing the benchmark interest rates longer than previously expected.
Many households have been biding their time on tracker rates, pegged to central interest rates, as fixed-rate deals soared in price at the end of last year.
But fixed rates have since fallen and experts are advising it may make sense for many to lock in, giving families the chance to cap soaring repayments. The cheapest fixed-price deals are already well below the typical tracker mortgage.
Trackers were priced significantly lower than the average fixed-rate mortgage during the economic fallout which followed the mini-Budget last year.
When mortgage rates peaked in mid-November the average two-year fix was priced at 6.65pc, while the average two-year tracker rate was 3.77pc – an interest saving of £360 each month on a £150,000 loan.
Homeowners piled in and there are now thought to be as many as 1.6 million households on variable rates.
But savings have shrunk as fixed rates have steadily dropped and the cost of trackers rose in line with the Bank Rate.
While this week’s rise will be passed on almost immediately to borrowers on tracker mortgages, and some on variable deals, lenders will have already priced the increase into their fixed rates, according to brokers.
The average two-year fixed rate is around 5.30pc, according to analyst Moneyfacts, and the typical two-year tracker priced at 5.07pc. A borrower with a £200,000 loan could save £38 a month in interest by opting for the tracker.
But the cost of a tracker will rise further in the coming days as lenders feed through the Bank of England rise. If the average tracker rate rose by the full 0.25 percentage point increase, to 5.32pc, the saving on the same loan would be wiped out.
There is no ceiling on how high repayments could rise, and their volatile nature means tracker mortgages are not appropriate for households that prize certainty over savings.
David Hollingworth, of broker L&C, said: “There was a spike in popularity of trackers after the mini-Budget when borrowers were faced with rapidly escalating fixed rates. That made trackers look substantially more attractive despite the fact that base rate was expected to carry on rising.
“As anticipated, Bank Rate rises have been feeding through and there could be more to come beyond today. As a result, tracker rates are in some cases now looking higher, or at least on par with some of the corresponding fixed rates.”
However, said Mr Hollingworth, many borrowers will be holding off in the expectation that fixed rates will fall further as Bank Rate drops later in the year.
Now read: As interest rates rise, use our mortgage calculator to see how much more you will pay
Where can I find the best deal?
There is an escalating price war between lenders who are competing for business to hit lending targets.
The average two-year fixed rate has fallen from 5.79pc to 5.30pc since the beginning of January, while the typical five-year rate has dropped from 5.63pc to 4.97pc in May, according to Moneyfacts.
But the cheapest deals have fallen even further, some dipping below 4pc.
According to L&C the best two-year fixed rate mortgage, for a 40pc deposit, is 4.29pc with Metro Bank with a £999 fee. The best five-year fix is 3.88pc with Lloyds Bank. By comparison, the cheapest two-year tracker mortgage is 0.14 percentage points above the Bank Rate – so 4.64pc after today’s rise.
It is important to remember that the lowest interest rates do not necessarily equate to the best deal. High fees can sometimes outweigh marginal savings on similarly priced interest rates.
Now read: Everything you need to know about remortgaging in 2023
How long should I fix for?
The cost of borrowing this year will remain inflated despite interest rate falls, serving as a shock for households coming off rates fixed two or five years ago. More than 1.4 million borrowers will pay higher rates this year as their fixed deal comes to an end, according to figures published by the Office for National Statistics.
Capital Economics forecasts the Bank Rate to peak at 4.5pc (see chart below) and remain at that level until February 2024.
But the biggest falls will come in early 2025, the consultancy predicted, when the Bank Rate is forecast to drop to 2.5pc by February of that year.
Mr Hollingworth said whether to ditch a tracker for a fixed rate now was the “£1m question”.
He said borrowers looking for a stop gap while the market was volatile “may want to lock into a fix now as rates have reduced substantially”.
But those who are “playing the long game”, may want to hold on, he said.
“The forecasts suggest that once inflation eases, there will be a falling back in interest rates which a tracker would follow down. There remains uncertainty about whether the Bank Rate is as close to its peak as previously thought given the stubborn inflation figures.
“Anyone holding firm [with a tracker] should brace themselves for more Bank Rate rises before it becomes clearer when and how far Bank Rate will fall.”
Martin Stewart, of brokerage London Money, said he would be advising clients on tracker deals to “hold on if they can stand the uncertainty of a variable rate” because fixed rates could “possibly fall further”.
Now read: ‘My mortgage has gone up £500 – and now I’m stuck with it for five years’
This article was first published on 2 February 2023, and is kept updated with the latest information.