As interest rates rise, is it time to look at other types of mortgages?
It’s estimated that nearly 75% of mortgages in the UK are on fixed rates, according to the Financial Conduct Authority.
This is hardly surprising following a historically low Bank of England base rate but, as this rises, variable rate mortgages and innovative, new mortgage products are set to increase in popularity.
“For a long period of time, the dilemma in mortgage advice hasn’t been whether to fix a rate but for how long to fix for,” says Tom Woodall, mortgage and protection adviser, at Prosperity Wealth Ltd.
“Now, we face a period where fixed rates have dramatically increased due to a variety of factors and, as such, other types of mortgages need to be considered for clients looking either to purchase a property or remortgage.”
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Variable rate mortgages take many different forms and don’t come with the security that you get from a fixed rate mortgage.
“We all have different attitudes towards risk, so we should be looking at all options available and not just fixed rates, to help us make informed choices,” says Mark Humphrey, director of MHC Mortgages.
So what other mortgages are out there?
Tracker and discounted mortgages
Tracker mortgages follow a rate that’s a little above the Bank of England’s base rate, while discounted mortgages are similar but track at a rate a percentage point below the lender’s standard variable rate (SVR).
Both of them can go up or down but a tracker’s rate is set independently by the Bank of England, while a discounted rate is set by the lender.
For this reason, these both come with an element of risk, but there are advantages too.
“Discounted and tracker mortgages will typically be cheaper now and, if your budget can cope with any potential rate increases and you believe rates have peaked/will start to reduce, then these products may be right for you,” says Polly Gilbert, from Tembo.
“Although most lenders have repriced their variable rate mortgages, clients are acknowledging that SVRs and the base rate would have to increase fairly starkly to meet the current fixed rates on the market,” says Woodall.
Apart from lower costs, these types of mortgages come with other advantages.
“With tracker rate mortgages, generally there are no early repayment charges,” says Woodall.
“This has led to an emergence of the ‘switch to fix’ mentality across the market… utilising a tracker product with lower monthly costs and no early repayment charges whilst the Bank of England rate is closely monitored. As a contingency, the plan is to switch to a fixed rate if the Bank of England rate spirals and pushes monthly payments beyond budget.”
There is a risk with this, however, that if the Bank of England’s rates get too high, even a fixed rate deal is beyond a client’s affordability.
In general, affordability is key when taking out these types of mortgages.
“The danger of this is where an adviser recommends a tracker or discounted rate which has a monthly cost close to the client’s maximum monthly budget,” says Woodall.
“We are likely to see further increases in both respective rates and therefore the monthly payments could go beyond the client’s budget. In a worst-case scenario, clients may then be unable to afford their mortgage payments and risk the possibility of their house being repossessed by the lender.”
Capped mortgages are another type of variable rate mortgage.
In a similar way to a tracker, your rate tracks that set by the Bank of England base rate and can move up and down, but it cannot go above a set "cap".
“[They were] popular in the early noughties, but disappeared when fixed rates became cheaper than many variable rates,” says Humphrey. “These aren’t widely available, but we may start to see these being reintroduced.”
Capped mortgages are often cheaper than fixed rates and you have the advantage and peace of mind that your rate won’t go above the cap.
These mortgages allow you to use your savings towards your mortgage balance, so you pay less interest in total.
You won’t earn interest on your savings and, at a time when interest rates are increasing, that isn’t great, but you’ll have easy access to your money and it’s a tax efficient way of using your savings.
There are disadvantages though — interest rates are often a little higher and there are very few fixed rate options available. That said, “those with savings, even as little as a few thousand pounds, can make a difference,” says Humphrey.
Family assisted mortgages
There are also new mortgage products coming onto the market.
“With home ownership in the UK continuing to be out of reach of many first-time buyers, family assisted mortgages will certainly grow in popularity in 2023,” says Gilbert. “Income and deposit boost mortgages are already helping hundreds of people unlock generational wealth.”
These mortgages suit those with family who are prepared to help them get on the property ladder, “either through using their income towards a mortgage application and/or unlocking equity from a current property towards the buyer’s deposit”, says Gilbert.
The disadvantages are that many people don’t have family in a position to support them, which could only exacerbate inequality.
Green mortgages reward those moving into energy-efficient homes or those who make their homes greener.
This is done by offering a lower interest rate or through cashback on their mortgage.
“Green mortgages are a super option for those who are passionate about supporting climate change and, in return securing a lower rate, but, for some, the costs of making a home truly energy efficient may be too much of a stretch financially,” says Gilbert.
While fixed rates were always going to rise, the mini-budget accelerated this change and made variable rate and other mortgages more appealing.
“Overall, the lending landscape has become more varied and more complex,” says Woodall. “It’s time for mortgage advisers to be advisers and ensure they explain the range of options available to their clients.”