What is a variable rate mortgage?
Our guide to understanding what variable rates are and how they work. Explore the pros and cons of variable rate mortgages, decide if they're right for you, and then compare our best deals.
What is a variable rate mortgage?
A variable rate mortgage is a type of mortgage loan in which the interest rate can fluctuate over time, based on changes in the market interest rates or other factors determined by the lender.
The interest rate on a variable rate mortgage is typically tied to an index, such as the prime rate or the London Interbank Offered Rate (LIBOR), and can change periodically, often every month or every year.
As a variable interest rate can change over time, it can provide less certainty about how much you need to pay for your mortgage each month.
How variable rates differ from fixed rates
When you take out a mortgage, you’ll be able to choose a fixed or variable rate mortgage.
Fixed mortgages have interest rates that are set for a period of time. They let you know exactly what you’ll pay each month for the whole fixed period.
With a variable rate mortgage, the interest rate can change at any point of the mortgage, meaning your monthly payments could change.
How does a variable rate mortgage work?
A variable rate mortgage is a type of mortgage where the interest rate can fluctuate over time, based on changes in the Bank of England base rate or other factors determined by the lender.
Here's how it works in more detail:
Initial rate period: A variable rate mortgage usually has an initial rate period, during this time the interest rate remains fixed. This period can range from a few months to several years, depending on the terms of the loan and the lender.
Interest rate adjustments: After the initial rate period, the interest rate on a variable rate mortgage can move up or down, based on changes in the Bank of England base rate or other factors determined by the lender. Some variable rate mortgages may have caps or collars on how much the interest rate can increase or decrease during each adjustment period.
Monthly payments: As the interest rate on a variable rate mortgage adjusts, your monthly mortgage payments will also adjust up or down.
You should carefully consider the potential risks and benefits of a variable rate mortgage. Consult with a mortgage broker if you need advice.
The initial interest rates for variable rate mortgages are usually lower than the interest rates for fixed-rate mortgages. This is because the lender is taking on less risk by offering a variable rate mortgage, as the interest rate can adjust over time to reflect changes in the market.
There is no lock-in period on a standard variable rate mortgage. This means that you will be on a standard variable rate mortgage until you choose to switch to a fixed-rate or other mortgage rate type.
As there are no restrictions like what you may get with a fixed-rate mortgage, you will not be charged an early repayment charge (ERC) for changing to a different mortgage type.
How often a variable rate changes will vary depending on the lender or rate it is based on. For example, a standard variable rate (SVR) will change at the lender’s discretion, so it’s hard to say when your SVR will go up or down.
Types of variable rate mortgages
There are three primary types of variable rate mortgages, each with its own features and benefits.
1. Standard variable rate mortgages
This is the most basic type of variable rate mortgage, where the interest rate can fluctuate over time based on changes in the market interest rates or other factors determined by the lender.
Every lender has its own Standard Variable Rate (SVR). However, borrowers tend not to choose SVRs as they are often high. The average SVR reached a high of 5.25% in August 2022. ¹
Customers often roll onto an SVR after their fixed rate, tracker or discount period ends.
2. Tracker mortgages
A tracker mortgage is a type of variable rate mortgage where the interest rate is tied to an external benchmark, such as the Bank of England base rate or the LIBOR. The interest rate will "track" the benchmark rate, meaning that it will move up or down in line with any changes to the benchmark rate.
Tracker products usually last 2 or 5 years, but you can also get 3-year, 10-year and ‘lifetime trackers’. These track the base rate for the lifetime of the mortgage.
Your tracker mortgage could include a minimum interest rate or 'collar'. The interest rate will never fall below this so the lender will always make some profit.
Some lenders will also have a cap to restrict the maximum rate.
Some tracker mortgages have no Early Repayment Charges (ERCs). This allows you to make larger overpayments or repay the mortgage in full without being charged a fee.
3. Discounted variable rate mortgages
A discounted variable rate mortgage offers an initial discount off the lender's standard variable rate. For example, the interest rate on a discounted variable rate mortgage might be set at 1% below the lender's standard variable rate for the first 2 years.
After the initial discount period, the interest rate will revert to the lender's standard variable rate.
Unlike other variable rates, discount variable rates track the lender’s SVR instead of the Bank of England base rate. This means the lender could change the rate. Most lenders only change the SVR if the Bank of England base rate rises or falls.
Discount mortgage rates are often fixed for a term. This term can last 2, 3, or 5 years, for example.
Advantages of variable rate mortgages
Here are some potential advantages of a variable rate mortgage:
Lower initial interest rate: Variable rate mortgages often offer lower initial interest rates than fixed-rate mortgages, which can make them more affordable.
Potential for lower payments: If interest rates decrease over time, borrowers with variable rate mortgages may benefit from lower monthly payments.
Flexibility: Variable rate mortgages may offer more flexibility than fixed-rate mortgages, as borrowers can typically make additional payments or pay off the mortgage early without incurring penalties.
Protection against rising interest rates: Some variable rate mortgages have a cap on how much the interest rate can increase over time, which can provide some protection against large increases in monthly payments.
Potential cost savings: If interest rates remain low or decrease over time, borrowers with variable rate mortgages may save money over the life of the loan compared to borrowers with fixed-rate mortgages.
Disadvantages of variable rate mortgages
Here are some potential disadvantages of a variable rate mortgage:
Uncertainty: The interest rate on a variable rate mortgage can fluctuate over time, which can make it difficult to budget and plan for your monthly mortgage payments.
Risk of higher payments: If interest rates rise over time, as a borrower with a variable rate mortgage, you may see your monthly mortgage payments increase, which can make your mortgage less affordable.
Lack of control: You’ll have less control over their monthly mortgage payments, as they are subject to changes in the market interest rates or other factors determined by the lender.
Potential for higher costs: If interest rates rise significantly over time, you may end up paying more over the life of the loan compared to borrowers with fixed-rate mortgages.
Potential for negative equity: If interest rates rise significantly and property values decrease, you may end up owing more on your mortgage than your home is worth.
It's important to carefully consider the potential risks and benefits of a variable rate mortgage before choosing this type of loan and to consult with a financial advisor or mortgage broker for guidance.
What to be aware of when coming to the end of your initial term
Once your initial term is over, you're likely to end up paying the lender's SVR.
If you’ve signed up to Better.co.uk, we’ll let you know when it makes sense to think about switching. This way you can avoid paying the SVR if you choose to look at other deals.
If you use Better.co.uk to find a mortgage, we’ll look at both variable and fixed rate options to recommend a deal. We'll base the deal on what we think would best suit your needs.
Compare our best variable rate deals
Now you know how they work, how about looking at what deals are available?
Visit our variable rate deals page and compare some of our best deals using our comparison tool.
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Bank of England base rate guide
Find out more about the Bank of England base rate