What are the pros and cons of a tracker mortgage?

Our reader asks: I’ve seen a lot in the news lately that mortgage rates are going to fall. Is it worth me taking a tracker mortgage until I can get a much cheaper rate locked in later on?

Polly Gilbert from Tembo responds: The key benefit of a tracker mortgage is that you’re not locked in and left overpaying if rates come down. If interest rates drop significantly, and you find yourself locked in on a five-year product term with a hefty early repayment charge to get out of it, you could – by comparison – save money by being on a tracker deal which would drop automatically.

Tracker mortgages also offer more flexibility than fixed-rates, as they often have no or little early repayment charges (ERC). This can make it easier to switch to a new deal if you want to change providers or move to a fixed-rate deal.

For this reason, some customers might use a tracker deal if they know they might be moving or selling in the next year or so, or if their future at the property isn’t certain. Be aware that some tracker products do have ERC’s so do check this.

The main drawback of trackers is that you will typically pay a higher rate of interest. You’re essentially paying more from day one, and gambling that rates will drop over time. Often rates would need to drop considerably for you to be “up” on the going rate.

For example, the best 2-year fixed rate deal right now is 4.67%, while the lowest tracker rate is 5.39% – that’s 0.72% more*. Hypothetically, if the base rate drops by 25 bsp to 5% in autumn (which it’s widely expected to do), it’s unlikely someone on a tracker would be on a better rate than if they had signed up to that 4.67% fixed rate. Then you’d be waiting with bated breath for the next MPC meeting in another 6-weeks.

When comparing options of two-year fixed versus two-year tracker deals, you need to consider the amount of time it would take for rates to come down enough. If it took a year and a half for your tracker deal to drop below the original fixed rate, there might not be enough time left on the tracker for you to make up the money lost on paying higher repayments up until then.

There are longer term tracker products available but these come with higher interest rates of circa 6%+ and therefore create a greater margin of rate improvement needed for it to make financial sense.

The second drawback of a tracker is that you don’t know what your monthly repayments will be each month. With a fixed rate mortgage, you have certainty for the years ahead, for budgeting, planning, even mapping out overpayments.

We always advise customers that if a rate of 2-3% above the current best tracker deal looks terrifying, then a tracker might not be for them; you have to be comfortable with a certain level of risk and variance.

Despite the media furor around the base rate and the potential for lower rates later this year, we haven’t actually seen a big increase in customers opting for tracker deals. With the cost of living crisis still pinching, a lot of people want the security of a fixed rate product, and for others, the current fixation on rates means that a ‘4-something’ rate is much more appealing than a ‘5-something rate’.

Ultimately, what’s best for each person is down to their individual circumstances, the level of risk they are comfortable with and how much flexibility they need. This is why it’s always best to seek expert advice when it comes to choosing a mortgage deal.

It may look like a fixed-rate mortgage is the best option when you look at simple comparison sites. But this doesn’t take into account your risk appetite, if you could cope with rate rises financially, or what flexibility you might need to exit a deal.

*Accurate as of 2nd July 2024. Based on 60% LTV, 35-year mortgage term. Your home may be repossessed if you do not keep up monthly repayments.

Photo by Alena Darmel