Tracker mortgage payments are directly linked to the Bank of England’s base rate. As their name implies, the rates of these mortgages can go up and down – depending on the market. With the base rate currently at an historic low of 0.5%, people with tracker mortgages have extremely low mortgage repayment rates at the moment.

Read on for the full Moneymagpie guide to tracker mortgages. It will tell you what they are, whether they’re right for you, and how to get the best one.

• What is a tracker mortgage?
• Who are they suited to?
• Things to watch out for
• How do you get one?
• Go to our mortgage comparison service for the best deal for you

What is a tracker mortgage?

Tracker mortgages are directly linked to the base rate. Most set a percentage that is just above the base rate. So say it’s set at 1% above base rate, and the base rate is 5% – then your mortgage will be 6%. This is great when rates are going down (and they’re though the floor at the moment) – but when rates rise, so will your repayments.

Unlike discount and capped rate mortgages, tracker mortgages are not linked to a mortgage lender’s Standard Variable Rate (SVR). This is the lender’s rate that is set above the base rate – and which the lender can change at any time. Although SVR based mortgages are also affected by the base rate, they are generally slower to follow in the event of the base rate being cut.

When interest rates are low or falling, tracker mortgages can offer some of the cheapest deals around. However, if base rates rise, it makes it hard to judge what your monthly mortgage repayments will be.

Who are they suited to?

Tracker mortgages are ideal for those who are looking for cheap repayments, but have the flexibility in their budget to cope with rate increases when they occur. Such mortgages don’t offer the security of fixed-rate deals, where you know what rate you’ll be paying for years to come (which makes budgeting a lot easier!).

The huge fall in interest rates is giving people with tracker mortgages extremely low mortgage payments at the moment. This is an advantage in itself. What’s more, when rates are low those with tracker mortgages are more likely to be able to overpay on their mortgage – without increasing their previous level of expenditure. This not only lets them pay off their mortgage quicker, but ends up costing them less in the long run.

The quicker you pay off your mortgage while rates are low, the less interest you end up paying and the fewer payments you have to make when rates are high. Just make sure your mortgage contract doesn’t penalise you for early repayment, as being able to overpay is one of the chief benefits of getting a tracker mortgage.

Also, by building up equity in your property, you won’t need to borrow as much when the time comes to remortgage – which will enable you to get a more competitive mortgage deal. Check out the best tracker mortgage deals here through our independent mortgage comparison service.

Things to watch out for

The state of the market

It generally makes sense to avoid getting a tracker mortgage when the base rate is high or rising. But although interest rates are currently at an all-time low, tracker mortgages aren’t as popular as you might imagine at the moment. There are a number of reasons for this.

Firstly, people think that rates can’t get any lower and the only way is up. There’s some sense in this, as large government borrowing (as is happening during the current recession) tends to lead to interest rate rises in the longer term. Also, new tracker mortgages now track as much as 2.5% above the Bank of England base rate. Put simply, the tracker deals that are available today aren’t as competitive as those that were available just a couple of years ago.

However, don’t dismiss tracker mortgages out of hand. Fixed-rate mortgages have been subject to sharp increases in recent weeks, as banks want to protect their fixed mortgage profits from potentially steep base-rate rises that may occur in the future. “The premium over the initial tracker rate one now has to pay to secure the interest rate protection provided by a fixed-rate for 5 years or longer has risen to well over 2%,” says Ray Boulger at John Charcol. In other words, the base rate needs to rise to over 2% to make current fixed-rate deals really worth your while.

Although fixed-rate mortgages offer you more security (you know exactly what you’re going to be paying throughout your mortgage), security shouldn’t come at too high a price. If you’re considering getting a fixed-rate mortgage, be sure to check out our guide to them here.

While the economy shows some signs that it could be beginning to stabilise, interest rates aren’t going to skyrocket in the immediate future. “We could well be in for a very bumpy period for some considerable time to come,” says Howard Archer, chief UK and European economist at forecaster ISH Global Insight. “Bottom line: interest rates look poised to stay at 0.5% well into 2010.”

No-one can say for sure, but many commentators believe that interest rates will stay low for even longer (though probably not at the rock bottom rate of 0.5%). This could well be the case – unemployment is still rising as the recession continues to bite, and last month inflation slipped under the Bank of England’s 2% target. So interest rates certainly aren’t going to reach the 5.25% they were at in March 2008 any time soon.

The banks’ own borrowing costs have also fallen. The Libor (the rate at which banks lend to each other) recently fell to below 1% – its lowest rate since the 1980’s. However, unfortunately this probably won’t translate into lower mortgage rates for banks’ customers…

Arrangement fees

It costs money to set-up a mortgage, and most lending institutions are only too happy to charge you for it! Whether you’re a first-time buyer or re-mortgaging, the arrangement fee can sometimes break the £1,000 barrier. An increasing number of lenders are charging arrangement fees that are a percentage of the loan amount (say 1%) rather than a fixed fee, in order to get to the top of the ‘best buy’ tables. So if you want the best rate you pay a bigger fee.

As a general rule, the bigger your mortgage, the less important the fee is – because the interest rate is much more significant. So it might be worth paying the fee in order to get the cheap rate. If you have a small mortgage though, the size of the fee is important – as the money you’ll be charged from interest will be a lot less.

Early repayment charges

A mortgage is a massive debt, and we think that the sooner you get it cleared, the better. However, as far as the bank is concerned, they want you to keep your mortgage for as long as possible, so you keep paying them interest.

To try to limit how quickly you can pay off your mortgage, some tracker mortgages will have early repayment charges. These charges vary enormously by provider. They are sometimes calculated as a percentage of what you overpay (rather than being a flat fee). This means that the faster you try to repay your mortgage (i.e. the more financially responsible you are), the more they charge!

If a tracker mortgage seems to be a good deal but has high early repayment charges, think twice before signing up. One of the key benefits of tracker mortgages is that when rates are low or falling, they give you an opportunity to overpay your mortgage payments (without having to increase your expenditure). High early repayment charges nullify one of the main advantages to having a tracker mortgage in the first place, so be sure to read the small print.

Higher lending charges

If you have little or no deposit, there may be a higher lending charge (HLC). This is to cover the cost of insurance taken out by the lender in case you default on your mortgage payments, and there is any shortfall in what you owe the lender once your house has been sold.

An HLC is levied by some lenders when people are looking to take out a loan worth more than a certain percentage of the property (anything from 75% – 90% of the property’s value). Some sneaky mortgage providers may even only offer their headline interest rate on (for example) an 85% loan, while charging you at a premium should you require a higher loan-to-value.

The HLC is usually a percentage of the mortgage amount and could add up to a few thousand pounds – so avoid paying it if you can. Look out for a lender that doesn’t slap you with this charge, because it’s not common practice anymore.

Valuation and legal fees

If you are remortgaging, you may find that some lenders will offer free valuation and free legal fees. This could save you a few hundred pounds, so it’s worth considering.

Stamp duty, searches and conveyancing

Always bear in mind that there are far more costs to buying a house than just your mortgage. Stamp duty, land registry fees, surveys, conveyancing, broker fees if you use a broker… it’s a long list, so be sure to factor them into your budget!

How do you get a tracker mortgage?

That’s easy. Just go to our mortgage comparison service and speak to the excellent mortgage advisers at London & Country. They’re completely independent and search the whole of the market to bring you the best deals.

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