Variable Rate Mortgages

These are a very popular form of mortgage, the basic premise behind these is that they follow the Bank of England base rate, remaining at all times a set amount above it - they in effect 'track' with the base rate, hence variable rate mortgages are also commonly referred to as tracker mortgages.

With these mortgages, any changes made by to the base rate by the Monetary Policy Committee (MPC), which is the part of the Bank of England responsible for rate setting, will be reflected in the interest charges on variable rate mortgages. The committee meets every month to decide the rates, and in theory rates could change monthly, although in reality it is uncommon for them to alter more than twice a year at most.

For borrowers who have variable rate mortgages, a drop in the base interest rates is good news, as it will reduce the cost of their mortgage, and lessen their monthly repayments. Conversely, a rise in interest rates would mean that the mortgage cost would increase along with the monthly repayments made by the borrower. A variable rate mortgage exposes the borrower directly to changes in the economy, and so the type of person who takes such a mortgage is usually someone who is not adverse to risk.

With the risk there that the interest rates could rise dramatically, even to a point where they could make the mortgage unaffordable to the borrower, why would anyone choose such a mortgage? The answer is simple - in the right circumstances they can be a very cheap option. For a start, the 'premium' on such a mortgage, that is the amount that is added on top of the base interest rates, is very small compared to other mortgages, and provided rates remain fairly stable they can work out to be significantly cheaper than say a capped rate mortgage. If interest rates fall then this will make the mortgage cheaper still.

Lenders are able to offer very low comparative interest rates on this type of mortgage as they do not have to 'absorb' any additional costs that a rate rise would bring about, and therefore they do not need to price the mortgage in a way that would provide them with a buffer to help with absorbing those costs. The amount the lender earns remains the same regardless of interest rates, and so they can price to the minimum.

Whether a variable rate mortgage would suit a particular borrower depends a great deal on their circumstances, those who are taking on a mortgage that they can comfortably afford and who feel that rates are not set to rise dramatically will be best suited, as it provides cheap financing and even if rates should rise, they are in a position to be able to 'ride out' the expensive period. First time buyers who would be stretching to meet the repayments would be advised to look elsewhere, as rate rises could easily make that stretch into something unobtainable.

Variable rate mortgage do offer a very good solution for a number of people in the right situations, they can be a cost effective way to finance home buying. As long as the borrower is aware of the risk of the mortgage costs increasing, as well as the possibility of them decreasing, and is financially able to meet the mortgage repayments then they can be a good option to choose.