Fixed Rate, Tracker or Offset Remortgages: Which Should I Choose?

During the five or so years prior to the credit crisis there was a great deal of development of different types of mortgages and remortgages in the market place with capped , flexible, and self certified to name but a few that became readily available. In the current economic climate, the banks have diminished considerably the variety and scope of their mortgage products and now they primarily fall into the categories detailed below. It is important for anyone looking to take out a mortgage or a remortgage to fully understand the detail of each of these products before making a decision on which remortgage deal to take.

Fixed Rate Remortgages

A fixed rate remortgage is one in which the interest rate is set at a fixed level, generally for an agreed period of time and usually between 1 to 5 years. The benefits of this type of remortgage are that the monthly interest payment charged by the lender will remain the same for as long as the fix is in place regardless of any changes in Bank of England base rate or the lender’s own standard variable rate. This can be very useful for an individual who is on a fixed income and wants the security of knowing that their monthly mortgage payment will not change over the period of the fix.

Interest rates charged on fixed rate deals are usually slightly higher than the lender’s prevailing variable or tracker rates because the lender is taking a long term view of average rates over the period of the fix and will assume some rises as well as falls over time.

Aside from the comfort of knowing the monthly payment each month, there can also be financial savings for the borrower with a fixed rate. If bank base rates rise above the fixed rate and remain consistently higher over the fixed period then clearly you will be making monthly savings relative to someone who opted for a standard variable or tracker rate. However, the opposite is also true if interest rates fall and remain consistently lower than the fixed rate.

There are a couple of points of caution with fixed rate remortgages. Firstly, if, for any reason you need to redeem or pay back your remortgage at any point during its fixed term then it is almost certainly the case that you will have to pay the lender an early repayment charge (ERC). This is generally around 2-3% of the mortgage balance but can be as high as 6%. To avoid this situation be as sure as you can before taking out a fixed rate mortgage that your circumstances are unlikely to change over the period of the fixed rate.

Secondly, when your fixed rate period ends, if you have not arranged another remortgage deal, the mortgage is likely to revert to the lender’s standard variable rate. If, at that point in time interest rates are high, then there is a chance your monthly payment could be significantly more than you have been used to paying which could cause you financial difficulty. To alleviate this problem it can be a good idea to look for a new remortgage deal three months prior to the expiry of your current deal. Most lenders will issue an offer for a mortgage that remains valid for between 3-6 months which means you can have peace of mind knowing that everything has been arranged in advance.

Tracker Remortgages

A Tracker remortgage is a mortgage where the interest rate is set at a fixed percentage rate above (or sometimes below) the Bank of England base rate and then when the Bank of England base rate changes there is an equal change in your mortgage interest rate; hence, the name tracker as it is tracking the Bank of England base rate.

The base rate is set every month by the Bank of England’s Monetary Policy Committee and for the last year and a half, this rate has been maintained at its lowest rate since records began at 0.5%. Tracker remortgages are generally set at about 2.5% above the base rate so with rates so low, a tracker remortgage can seem like a very attractive deal. However, as with all remortgages it is important that you assess the details and conditions behind the deal in order that it suits your requirements. Often, there can be expensive early repayment charges (ERC) levied by lenders if you repay the remortgage early or before the end of the tracker period. Also, if bank base rates rise dramatically during the period of the tracker then this will increase your monthly payments. On an interest only mortgage of £100,000 a 1% increase in interest rates will result in a further £83 per month on your mortgage payment. Taking advantage of current cheap remortgage deals can undoubtedly be financially beneficial and save you money month on month but make sure that you will still be able to afford your monthly payments should rates rise by at least 1% – 2%.

Clearly tracker deals can be advantageous in periods of low or falling Bank of England base rates but essentially they are unpredictable and can cause financial issues if interest rates rise sharply over a short period of time. If you are the type of person who likes the security of knowing what your remortgage payments are going to be over the long term then possibly you should look at a fixed rate remortgage.

Offset Remortgages

An offset remortgage links your designated savings accounts to your mortgage loan and calculates the interest due each month on the net of the balances. For example if you had a mortgage balance of £150,000 and associated savings accounts with the mortgage provider of £50,000 then the interest charged will only be calculated on £100,000 i.e. the net balance. Bearing in mind the fact that interest rates currently payable on most savings accounts are so small then this can be a very efficient and beneficial use of your savings. From an income tax perspective there are also advantages as there is no tax due on the reduction of interest achieved through the offset facility. For a basic rate taxpayer with an offset mortgage at 3.5% then the offset facility is worth an equivalent gross savings rate of 4.4% and for a higher rate taxpayer this rises to 5.8%.

Another benefit of offset is that provided you maintain your monthly mortgage payments at the level initially agreed which will almost always be based on the gross mortgage balance then you will effectively be overpaying the mortgage each month by the amount of the reduction in interest charged which in turn will mean that your mortgage balance is reducing at a faster rate than originally calculated.

The final advantage of using your savings in an offset remortgage is that the savings element generally remains fully accessible for your use at any time. For example should you need to utilise your savings for any reason e.g. a family holiday or essential house repairs then you are free to do so without obtaining permission from the lender. The only downside to this is, of course, as the savings are reduced then the mortgage interest savings reduce too.

A couple of points to be wary of when considering offset remortgages; firstly, the initial rates offered on offset remortgage deals are often not quite as attractive as fixed rate remortgages and tracker remortgages and you will need to carefully weigh up which deal suits you best and whether you are making the most of your savings and secondly to wholly benefit from the reduction of time taken to pay off your remortgage then you will need to be disciplined in making sure that you maintain the original level of mortgage payments set for the gross mortgage balance.