What is a Variable Rate Mortgage?

With a variable rate mortgage the interest rate you pay, and therefore the monthly repayments you must make, could potentially go up or down. A fall in your variable rate can work in your favour, but there is always the risk that your payments could increase.

John Fitzsimons, Tim Leonard Last updated on 26 November 2021.
What is a Variable Rate Mortgage?

A variable rate mortgage is a type of mortgage where the interest rate you are charged can change over the course of your loan.

This can work to your advantage if the interest rate falls and sends your monthly repayments lower too. However, if interest rates rise so will your repayments, meaning the mortgage will become more expensive.

What are the different types of variable rate mortgage?

As variable rate mortgages come in various forms, it’s important to understand the differences between them.

Tracker rate

With a tracker rate mortgage, the interest rate you are charged follows the direction of another interest rate. Normally this will be the bank base rate as set each month by the Bank of England. If the rate being tracked goes up, the rate on your mortgage will rise; and if the rate goes down, your mortgage rate will fall too.

These rates are generally priced at a percentage point or two above the base rate. For example, if your mortgage rate is set at base rate plus 1% and the base rate is 0.1%, you will be charged a rate of 1.1%. Similarly, if the base rate were to increase to 0.5%, the rate on your mortgage would also rise, to 1.5%.

You may take out a tracker rate for a set period, say two years, or for the entire term of the mortgage. If you opt for a two-year tracker, for instance, after those two years have elapsed you will be transferred to the lender’s standard variable rate.

» COMPARE: Tracker mortgages

Standard variable rate

A standard variable rate, or SVR, is essentially a default mortgage rate that lenders can set for themselves.

Importantly, the SVR can be changed by a lender at any time, regardless of what is happening to other interest rates or any bank base rate. As a result, if you have a mortgage which is sitting on your lender’s SVR, you could see your mortgage repayments increase or perhaps decrease at any time.

The SVR is often considered a default rate because it’s the rate you’ll automatically be switched to once your initial fixed or variable rate comes to an end. As an SVR will typically be more expensive in comparison, most people choose to remortgage to a new mortgage deal. If you don’t, you will remain on the SVR until the end of your mortgage term.

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Discount rate

A discount mortgage works by offering a rate that tracks at a discount below a lender’s standard variable rate. So if your lender’s SVR is set at 5%, and the discount is 2%, the interest payable on your mortgage would be 3%. Similarly, if the SVR rises to 6%, your interest rate would increase to 4%.

Discounted rates tend to be offered for a period of two, three or five years ‒ once that ends, unless you remortgage, you start paying the SVR itself.

Given their link to the SVR, the main consideration with discount mortgages is the potential for your interest rate, and therefore your monthly repayments, to rise unexpectedly if the SVR increases.

» COMPARE: Discount rate mortgages

Variable rate mortgage advantages and disadvantages

As with any type of mortgage, a variable rate mortgage brings with it both potential benefits and drawbacks.

Advantages of variable rate mortgages

  • Tracker rates and discount rates are often lower than fixed rates (though SVRs generally are not).
  • If you have a tracker rate and the linked base rate falls, or you have a discount mortgage or you are on an SVR and your lender chooses to lower its SVR, your monthly mortgage repayments should decrease.
  • If you are on a lender’s SVR, you are free to switch to another mortgage deal at any time.

Disadvantages of variable rate mortgages

  • There is no certainty over your interest rate, and therefore your monthly repayments, with a variable rate mortgage.
  • If wider interest rates or the bank base rate rises, your mortgage payments are likely to rise.
  • You need to have money set aside or room for manoeuvre within your budget to cover any rise in your payments.
  • If interest rates or the bank base rate fall, there is no obligation for a lender to follow suit and lower its SVR.
  • You might need to pay an early repayment charge should you want to exit a tracker or discounted mortgage before your deal ends.
  • Standard variable rates will almost always be among the most expensive mortgage rates available.
  • Some discount mortgages have a minimum rate ‒ or collar ‒ that your mortgage rate is not allowed to drop below.

Should I choose a fixed or variable rate mortgage?

The answer to this will depend greatly on your circumstances and the amount of risk you’re willing to take regarding rate movements.

The biggest selling point of a variable mortgage is where it comes in cheaper than what is offered by a fixed-rate mortgage, as well as the opportunity for your monthly repayments to decrease if your interest rate falls.

But the downside of a variable rate is that there is no certainty it will remain cheaper because there is always the chance that your rate, and consequently your repayments, may increase over time. As a result, over the term of the mortgage, a variable rate could end up costing you substantially more than you anticipated at the start ‒ there is simply no way of knowing for sure.

If you are happy to accept that risk in the hope that you end up saving money, a variable rate mortgage may be for you. Otherwise, the certainty offered by a fixed-rate mortgage, when you know precisely what your mortgage repayment will be each month for the length of that fixed term, is likely to make more sense.

» COMPARE: Fixed-rate mortgages

The absence of early repayment charges on some variable rate mortgages might also make them more appealing to some borrowers than a fixed-rate mortgage, when exiting the deal early will almost always involve a financial penalty. For instance, you might be able to find a low-rate tracker mortgage without exit penalties that is much cheaper than a fixed rate.

Then, if you think the base rate is about to increase, or your circumstances change and you are no longer comfortable with the risk associated with a variable rate, you could still switch to a fixed rate without having to pay an additional charge.

Similarly, if you are considering moving house in the near future or paying off your mortgage, opting for a variable rate mortgage without early repayment charges, or remaining on your lender’s SVR, would allow you to do so without facing penalties.

» MORE: The fixed vs variable mortgage rate dilemma

How to find the right mortgage for you

Carefully assessing all of your mortgage options is crucial to finding a deal that is suitable for you.

If you’re in any way unsure, you may want to make use of a mortgage adviser, often known as a mortgage broker, who will be well placed to help you work out what type of mortgage best meets your needs. Often a broker will also have access to lenders and individual products you may not be able to get as a direct borrower, which could improve the range of options open to you.

It’s also important to remember that the very lowest mortgage rates tend to be reserved for borrowers with the best credit scores. It is usually worth trying to improve your credit score if it’s not as polished as it could be, to have the chance of accessing the best variable mortgage rates.

» COMPARE: Variable rate mortgages

Image source: Getty Images

About the authors:

John Fitzsimons has been writing about finance since 2007. He is the former editor of Mortgage Solutions and loveMONEY and his work has appeared in The Sunday Times, The Mirror, The Sun and Forbes. Read more

Tim draws on 20 years’ experience at Moneyfacts, Virgin Money and Future to pen articles that always put consumers’ interests first. He has particular expertise in mortgages, pensions and savings. Read more

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