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Beat expensive fixed rate mortgages with these three alternatives

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11/11/2022
Fixed rate mortgage deals jumped in the aftermath of the disastrous mini Budget, and while some homeowners rushed to lock in, others have taken out alternative mortgage deals.

This time last year, two-year fixed mortgage rates stood at an average 2.29%, while five-year deals across all loan-to-value deals were recorded at 2.59%.

Today, homeowners looking at the same fixed rates can expect to pay significantly more, as deals are priced at an average 6.35% and 6.12%, according to Moneyfacts data.

They rose sharply following the ill-fated mini Budget in September with its raft of stealth – and unfunded – tax cuts which shook the markets.

While the two-year rate has come down from the peak of 6.65% last month, and the 6.51% for five-year rates, many new homeowners and those remortgaging are likely to be in for a price shock, particularly for those coming off of best buy deals two or three years ago which hovered around the 1% mark.

As brokers saw an influx of enquiries and saw homeowners do the ‘unthinkable’ in ending their contracts early and paying a hefty penalty for doing so to lock in rates before they were expected to rise further, for others, they’ve noticed a resurgence of mortgage alternatives.

Here are three alternatives to fixed rate mortgages:

Tracker mortgages

As the name suggests, a tracker mortgage tracks the Bank of England base rate, typically at a set margin above this amount, LDNfinance explains.

Compared to a fixed rate mortgage, there are no set monthly payments as it can rise or fall in line with changes to the bank rate. Borrowers usually take out two year or lifetime tracker deals.

LDNfinance says tracker rates can potentially offer a lower initial rate and monthly payment than a fixed rate and can also offer increased flexibility for the borrower in terms of overpayments and early repayment charges (ERCs).

According to Moneyfacts, the average two-year tracker rate stands at 4.12%, much lower than the equivalent two-year fixed mortgage deal.

And an October data sweep by Twenty7Tec reveals that as total searches for fixed products dropped in the month, tracker mortgage search volumes rose over 50%.

This is echoed by Mike Staton, director at Staton Mortgages, who says: “We have seen a major increase in the amount of tracker mortgages being taken out by clients; these clients are wanting flexibility at the moment ahead of stability.”

He reveals his firm has seen a “massive 75% of tracker business in the last month” whereas previously he would see around one case every three months.

“We’ve been in an era of ‘fixed rates is best’, possibly for the last 10 years where interest rates have been historically low,” he says, adding that as tracker rates start from 3%, it was “easy to see” the appeal.

Staton explains they are typically used by those who may move in the near future and can come out of a deal without penalty.

“A tracker gives you flexibility now that fixed rates aren’t enticing enough and they’re for people who feel interest rates will drop.”

He gives the example of the Barclays tracker of 0.75% above the base rate so 3.75%. “When you compare it to the 6% plus fixed rate deals, it’s phenomenal.”

However, Staton was able to tap into a 2.94% exclusive two-year tracker deal for a homeowner with a property worth £500,000 and an outstanding mortgage balance of £110,000 over a 17-year term. This client would pay £685 per month over the two-year period, compared to the £822 on a 5.35% two-year fix, a difference of more than £130 a month.

Staton shares his opinion that “in 18 months’ time, base rate will drop so tracker customers will win”.

However, he warns trackers do come with an element of risk especially if the bank rate were to rise.

“Do be careful though as not all trackers are penalty free and some come with tiny rules that if missed, could see you stuck with that lender for the long term.”

Offset mortgages

An offset links a mortgage to your savings and the balance of your savings is used to reduce the amount of interest charged on the mortgage.

This means borrowers only pay interest on the mortgage balance minus their savings balance. The savings do not repay the mortgage, but it sits alongside and saves interest.

As an example, if you had £100,000 in savings and a £150,000 offset mortgage, you would only pay interest on £50,000.

Similarly to trackers, brokers have reported renewed interest in these products, particularly as households squirreled away savings during the pandemic, which now can be put to good use, especially where the balance is earning little to no interest.

Scott Taylor-Barr, financial adviser at Carl Summers Financial Services, says: “Offset mortgages are an excellent, if very underrated, financial planning tool. Using your savings to help reduce the interest paid on your mortgage, whilst having full access to the savings if you need them, is a very powerful way to use your money.”

Coventry Building Society’s Jonathan Stinton says there was an assumption that offset mortgages “only work for big earners and big savers” but that was not always the case.

“While it’s true that offset is usually attractive to these types of clients, the products are not exclusively designed for them. Clients at the other end of the scale, with lower mortgage balances and less held in savings, could still see their money working harder for them with an offset product,” he says.

However, one draw back is that there aren’t too many offset mortgages on the market. According to Criteria Brain, there are nine lenders who can offer a residential offset mortgage and two that can offer a buy-to-let offset mortgage.

Jonathan Burridge, founding adviser at We Are Money, says part of the issue with these products is that they are often “priced at a premium” and when you compare the savings of offsetting against standard products, “there is very little in it”.

But a number of brokers say with interest rates on the rise, there could be a large demand for them over the next few years.

Riz Malik, director at R3 Mortgages, says: “Given the growing spread between borrowing costs and the return on savings, offset mortgages could return to popularity for those with large savings balances.

“The advantage of offset is that you can benefit from saving money on your mortgage but do not lose access to the funds. The number of lenders offering offsets has diminished over recent years but used correctly can reduce the term of your mortgage.”

Chris Sykes, technical manager at Private Finance gave details of a recent client who needed £500,000 to buy a property and they wanted to borrow an additional £250,000 for works on the property over the next two years. They needed instant access to funds but the 5% interest would mean it would cost them £12,500 a year if it was not offset.

Discount mortgages

While trackers track the Bank of England base rate, discount mortgages have a variable rate and a discount off this rate. As an example, you could have a variable rate of 5.89% and a 2.9% discount off this.

The big difference here, according to Staton, is that the variable rate “can go up or down at a lender’s whim”, so they can hike the standard variable when they want.

Staton says these products are more suited to “adventurous attitudes” as with the Bank of England “you know where you stand”, but with these variable rates “they go up and down at the lender’s discretion”.

He says in the last couple of months, these rates have been hiked but based on the client with the £500,000 property with £110,000 mortgage outstanding, this is one of the cheapest mortgage on the market – a 2.99% discounted deal which would see them pay £687 a month over two-years, with a £499 fee.

However, he cautions: “There’s no guarantee it will be the cheapest tomorrow”.

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