Loans that follow the leader

Pegged to Bank of England base rates, tracker mortgages offer few surprises for borrowers, says Stephen Pritchard
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Since last summer, the Bank of England has increased interest rates three times, to their current level of 4.25 per cent. Borrowers with tracker mortgages have seen their interest bills rise by the same amount. Trackers are designed to follow bank base rates or, less often, the London Inter Bank Rate (LIBOR), so there is no escaping rate hikes. But borrowers with tracker loans could well be better off than homeowners with other, variable rate loans.

Since last summer, the Bank of England has increased interest rates three times, to their current level of 4.25 per cent. Borrowers with tracker mortgages have seen their interest bills rise by the same amount. Trackers are designed to follow bank base rates or, less often, the London Inter Bank Rate (LIBOR), so there is no escaping rate hikes. But borrowers with tracker loans could well be better off than homeowners with other, variable rate loans.

Homeowners with tracker loans know upfront the difference between base rates and the rate they pay. When rates do rise, the increase is easy to work out. Homeowners who take out deals based around lenders' standard variable rates can be less fortunate.

"Trackers have the advantage of being transparent," says David Hollingworth, at brokers London & Country Mortgages. "When interest rates rise, standard variable rates are more likely to go up by more than base rates than by less."

Research by London & Country shows that a wide range of lenders took advantage of last month's base rate increase to put up their standard variable rates. West Bromwich building society increased their standard variable rate by 0.31 per cent to 6.30 per cent, Nationwide by 0.35 per cent to 5.49 per cent, Scottish Widows Bank by the same amount to 5.59 per cent and Northern Rock 0.30 per cent to 6.29 per cent.

Borrowers on a tracker deal, however, will be paying just 0.25 per cent more. Five years ago, tracker mortgages were relatively rare and appealed to a minority of buyers. Today, large lenders including Halifax and Abbey National offer tracker rates as standard to their new borrowers.

All trackers, however, are not alike. The market offers two main types of tracker: fixed term and lifetime. Some discount mortgages are also based on a tracking arrangement. Most fixed-period trackers run for between two and five years. According to Ray Boulger, senior technical manager at the broker Charcol, most borrowers opt for tracker periods of two to three years, as these currently offer the most competitive rates.

The most competitive of the fixed-period trackers start off at a discount to base rates, but most of these, along with the majority of tracker loans, revert to the lender's standard variable rate (SVR) after the tracker period. For most lenders, the SVR is their most expensive mortgage rate. There are some exceptions: the Woolwich has a tracker at base plus 0.04 per cent for two years, or without fees at 0.25 per cent. These revert to 0.95 percent over base for the remaining term.

Over the longer term, a lifetime tracker mortgage can work out better value than a fixed-period deal, even when the initial rate on the latter is cheaper. At Charcol, Boulger says that Newcastle Building Society's rate,at 0.49 over base, with no redemption penalties, represents a good deal. Only slightly more expensive is Abbey's tracker, at 0.5 per cent over base. The mortgage allows homeowners to offset their savings against the debt, so it represents good long-term value.

Norwich & Peterborough Building Society also has a range of lifetime trackers with flexible features and no penalties for early redemption. Mortgage advisers believe that competitive pressure will keep tracker rates keen, even as lenders' standard variable rates creep upwards. Although rates will rise or fall in line with the Bank of England's interest-rate policy, Boulger believes that the margin between base rates and the best tracker deals will stay steady, at around 0.5 per cent.

This means that for existing homeowners on fixed rate or discounted deals, there is little to be gained by choosing to switch to a tracker mortgage now, especially if there are fees or penalties to pay.

"It would not be worth coming out of your existing mortgage early, even if you had to pay 5 basis points (0.05 per cent) more for a tracker in a year's time," says Boulger.

But for home buyers, a tracker could be the best compromise right now between increasingly expensive fixed rates, and the risks of a discounted deal tied in to a lender's standard variable mortgage.

And among the tracker-mortgage options, the best deals of all could be those that offer a decent, "no frills" rate over the lifetime of the loan, or where there is a fixed tracking period but no penalties. That way, if a lender's rates start to look expensive, homeowners can vote with their feet and move their money elsewhere.

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