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Cover story: On track for recovery?

Tracker mortgages have enjoyed a mini revival in 2015 as they became cheaper than fixes. But will this recovery continue as borrowers plan for predicted rises in base rate?

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Rumours of the death of the tracker mortgage have been greatly exaggerated. Although nearly nine in 10 borrowers currently choose fixes – maintaining the product’s dominance – there has been a gradual increase in appetite for deals that track alongside the Bank of England base rate.

It is hardly a revival to mirror a phoenix rising from the ashes but cheaper rates, compared to those of fixes, have led to a noticeable uplift in demand for trackers this year.

Council of Mortgage Lenders spokesman Bernard Clarke says: “Our figures show that fixes are still eight times more popular than trackers but that trackers have enjoyed a mini revival in recent months and are now being taken out by a higher proportion of borrowers than for more than two years.

“Historically, borrower choices have often been shaped by the relative cost of different mortgage products and expectations for future interest rate movements. In recent months, borrowers have been spoiled for choice by the cheapest deals ever seen, and both fixed and tracker rates are at an all-time low.”

CML figures show that in 2013, 86 per cent of all UK mortgages were fixes, with trackers at 8 per cent. In 2014, 90 per cent of mortgages were fixes, with trackers representing just 5 per cent.

Yet in the first quarter of 2015 a tracker revival began: 88 per cent of new home loans were fixes, with trackers up to 9 per cent. Figures for April (the most recent data available) show the popularity of trackers increasing further to 11 per cent of all mortgages, with fixes falling to 87 per cent.

One of the UK’s largest brokers, London and Country, reports that around 90 per cent of clients are taking out fixes but, as with the overall CML data, that figure was even higher in the past.

L&C associate director of communications David Hollingworth says: “There are still around nine in 10 clients opting for a fix and I don’t expect that to shift appreciably. However, there have been periods where take-up of fixes dominated even more, so there is a little softening towards the variable options.”

It was not always like this. Just three years ago, fixes accounted for only 69 per cent of mortgages, with trackers representing 20 per cent. In 2010, fixes were at 50 per cent and trackers at 33 per cent, while back in 1996 fixes accounted for just 19 per cent of the UK mortgage market.

But fixed-rate deals have dominated over the past few years because there has been little difference between their overall costs and those of trackers.

In 2013, Moneysprite director Ashley Brown noted: “With fixed-rate options priced so competitively, there is little to be gained by customers choosing tracker deals, unless the Bank of England drops rates further.”

Price

So what has led to the tracker mini-revival? One reason is price.

Figures from data analyst Moneyfacts show that as overall rates have fallen from two years ago, trackers have got progressively cheaper relative to fixes.

In July 2013 the average two-year fixed rate was 3.63 per cent, compared to an average two-year tracker rate of 3.28 per cent – a difference of 35 basis points. By July 2014 the gap had widened further to 90 basis points, with a two-year fix averaging 3.67 per cent and a two-year tracker at 2.77 per cent.

As rates have plummeted over the past year, the differential has remained steady, now at 92 basis points. An average two-year fix is 2.92 per cent versus an average two-year tracker at 2 per cent.

Of course, rate alone does not take account of product fees but nevertheless it is a good barometer of typical costs.

An analysis of the best buys also shows the value of trackers to borrowers prepared to gamble against a potential rate rise. In mid-July, the cheapest two-year fix at 60 per cent loan-to-value was 1.05 per cent while the cheapest two-year tracker was 1.07 per cent. Despite the apparently favourable fixed rate, most borrowers would find the tracker better value because of its much lower product fees.

Long-term appeal

Trackers can also be useful for those seeking a long-term mortgage, whether because they are worried about being able to remortgage in future or because they are prepared to gamble that such a deal will work out for them in the long run.

In mid-July, the top 10-year fixed rate at 60 per cent LTV was 2.99 per cent, yet a lifetime tracker was available at 1.99 per cent without any early repayment charges.

“While pricing is relatively similar to a two-year fix, tracker pricing compares favourably to longer-term fixes,” says SPF Private Clients chief executive Mark Harris.

“Also, if the client requires a high-value mortgage, fixes are relatively uncommon at the upper end of the loan spectrum. Typically, a high-value mortgage fixed rate will only be decided on the day of completion and subject to the cost of funds, plus profit margin. This is typically more expensive than a floating charge.”

Gareth Morrison, principal mortgage consultant at Northern Ireland-based broker GM Mortgage Solutions, adds: “Long-term or lifetime trackers may still be appropriate for clients who do not want to revert to a lender’s SVR but to maintain their mortgage payments in line with the base rate.

“Some clients do not want to move to the SVR in case they can’t renegotiate a new deal with their existing lender or remortgage to another lender for any reason at the end of their tie-in period.”

Morrison points to another reason why trackers may appeal to some borrowers. He says: “When a client is limited to which lender they can use due to lending criteria restrictions, a tracker could be more attractive or the only option because of the deals available.

“An example in Northern Ireland might be a first-time buyer requiring a 95 per cent mortgage for a new-build property and only a variable rate is available.”

Charges

Another important difference between fixes and trackers is the often more flexible payment terms of the latter – in particular, the ability to overpay without the threat of an ERC.

Fixes tend to have more stringent rules, typically allowing a maximum overpayment of 10 per cent of the outstanding balance each year, with some lenders allowing even less. While 10 per cent is enough for many borrowers, some can afford bigger overpayments, such as those who routinely receive large bonuses or commission.

“Being able to make large overpayments when rates are low could also appeal to those wanting to reduce their debt level to place themselves in a better position when rates start to climb,” says Hollingworth.

Harris adds: “If clients are potentially looking for an ERC-free product, a tracker may be the answer. They may need a higher LTV initially and then develop or refurb the property before refinancing to a lower LTV with a cheaper rate.”

The lack of charges also makes trackers suitable for those who want a mortgage for only a short time; they will be able to pay it off in full without penalty whenever they want.

Anderson Harris associate Harry Arnold says: “Tracker rates are very competitive, currently providing the cheapest margins on the market.

“Most clients are still opting for fixed products if they have no plans to pay down the debt quicker. But clients looking to secure debt for structuring purposes, such as using the mortgage as a cheap bridging option, are opting for variable-rate deals with no ERCs.

“We recommend trackers if clients need a no-ERC option on their mortgage. They are suitable for clients looking for flexibility who want to achieve the very cheapest pay rates.”

Health warnings

Despite their appeal, trackers and other variable-rate products come with health warnings that may deter some borrowers – namely the reliance on lenders keeping their end of the bargain, whether legal or moral.

In 2013, Bank of Ireland famously announced that thousands of its customers with a base rate tracker would see their payments soar, although the base rate had not moved for four years. In some cases, customers experienced rises from 0.89 per cent to 4.49 per cent, which led to an increase in costs of more than £500 a month.

The lender cited a clause in many borrowers’ contract that allowed it to de-link trackers from the base rate after five years in “exceptional circumstances”.

John Charcol senior technical manager Ray Boulger commented at the time: “Essentially what it is saying is: ‘If we cock up, everyone else can pay for our cock-up.’”

Another controversial move a year earlier had seen Manchester Building Society raise rates for tracker customers who had taken out a mortgage in 2004 or earlier, citing clauses deep in its small print to justify the bad news. Those rises took place over two years, with some rates jumping from 0.99 per cent to 4.74 per cent. That increase added £3,230 a year to the cost of a £150,000 repayment mortgage with 15 years remaining.

It should be noted that such huge rises in tracker rates were not the norm and happened at a time when many lenders were still reeling from the effects of the credit crunch and struggling with many of their borrowers on record-low rates. They could never have anticipated that variable rates would fall so low when they sold those deals ahead of the financial crisis. Afterwards they paid the price but some made their borrowers pay rather than their own balance sheets.

There is little evidence to suggest that such massive rate hikes are about to strike again but the threat – albeit small – may still linger in some borrowers’ minds.

Fixed popularity

Despite the current mini-revival in tracker demand, fixes remain by far the most popular type of mortgage. The majority of customers want a straightforward mortgage, do not have the funds to overpay and cannot afford a rate rise, so for them a fixed-rate deal makes sense.

“The vast majority of borrowers are understandably looking for fixed rates,” says Hollingworth.

“With base rate at a record low, all the discussion is around when rates will start to climb, so with little to no chance of a rate cut, all the benefits seem to lie with fixed rates for many.

“That’s especially true when you consider that the price war between lenders has resulted in record lows for fixed rates. In many cases, there is little difference between the rates on offer for trackers over fixes.

“With rates likely to go only one way, fixing looks like a compelling option with very little downside.”

Moneyfacts spokeswoman Charlotte Nelson adds: “Historically, variable tracker rates offered borrowers the opportunity to secure the lowest monthly repayments, with borrowers asked to pay extra for the security of a fixed-rate deal.

“However, with fixed rates plummeting, there is little difference between opting for a tracker mortgage and opting for a fixed rate. This means borrowers can almost opt for variable-rate lows without any risk of the rate going up if base rate changes.”

The future of the base rate will naturally play on people’s minds when choosing a mortgage. The widely held prediction is that a rise in base rate could come between autumn this year and next summer, although the recent hint by Bank of England governor Mark Carney that it could happen this winter is the closest we have come to a statement of intent from what is, ultimately, the key decision-making vehicle on rates.

That said, ever since the base rate was locked down at its current historic low of 0.5 per cent in March 2009, various economists, industry figures and members of the BoE’s Monetary Policy Committee have predicted, at various times, when the base rate would rise again.

Few, if any of them, anticipated that base rate would remain at 0.5 per cent for so long, so how can we be sure that the current predictions of a rise next year will be fulfilled?

Nevertheless, such sentiment continues to influence borrowers’ mortgage decisions. Santander head of business development for mortgages Graham Sellar says: “There have always been and will continue to be people who prefer a variable-rate mortgage and those who prefer a fixed-rate product.

“However, with the mounting speculation around the impending Bank of England base rate rise, the market has seen a resurgence of fixed-rate mortgages and a significant uptake of both two- and five-year fixes.”

Hollingworth notes that those in the know have suggested that, whenever a rise begins, it is likely to be slow and steady.

He says: “Although there have been changes around expectation of when rates may shift, the consistent message from the Bank of England has been that those increases will be gradual.

“However, it can still be a sensible exercise for borrowers to look at worst-case situations to establish how comfortable they might be with higher payments.

“First and foremost, the borrower needs to understand the implication of rising rates. It’s helpful if they get a feel for their own ‘stress test’ by looking at how an uplift in rate would translate into their monthly payment, and play out different scenarios.”

With potential base rate rises in the minds of many borrowers, does this mean fixes will continue as top dog of mortgage products?

Hollingworth says: “I still think we should expect fixed rates to remain the product of choice for the majority of customers. Many borrowers naturally like to know where they stand and a fix does what it says on the tin.

“However, the tracker market should not be dismissed and products do have merit for the right borrower. As long as the horizon is in doubt for when rates will climb, there could be a small but appreciative market for low, flexible tracker deals.”

Harris adds: “The money markets have already priced in a single base rate increase but fixes have not increased accordingly.  An increase in lending capacity has meant fixes have remained relatively static, although we are past the days of sub-2 per cent, five-year fixes.

“Trackers are only for borrowers who can afford to be wrong if rates move against them. Those on a tight budget should always take the security of a fixed deal, even if it means paying slightly more overall.”

Right track for some borrowers

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Brian Murphy, head of lending at Mortgage Advice Bureau

Trackers are still highly relevant and play an important part in the market although they represent a smaller proportion of overall sales compared to three or four years ago. The take-up of variable rates in the first six months of 2015 has been just under 10 per cent of overall transactions. But interestingly, this is slightly higher among those remortgaging, with just over 13 per cent preferring the flexibility of variable rates during the first half of 2015.

Trackers in general offer lower rates than even the most competitive fixed rates. They therefore continue to be recommended to borrowers whose circumstances allow them to take advantage of the current ‘on the floor’ rates but who could also deal comfortably with a rise.

They are also often ideal for those who want to overpay their loan or pay off their mortgage at short notice but do not want to incur penalties. Many tracker products provide flexibility around overpayments and do not have early repayment charges.

With the average base rate tracker currently around 2 per cent, they remain by some margin lower than the average two-year fixed-rate deal. For those borrowers whose financial situation allows them to cater for an upward movement in rates, trackers therefore represent a significant saving.

Many also offer the flexibility to switch into a fixed rate at any time should the client need to do so.

It would be inappropriate to speculate on where rates may be in six or 12 months as the market has constantly defied previous predictions. Borrowers have benefited from the 0.5 per cent Bank rate for more than six years.

Some forecasters have suggested a possible base rate rise during 2015 or early 2016 but any increase is likely to be small to ensure the wider economic recovery is not blown off course.

As a consequence, brokers must continue to explain fully to prospective borrowers the range of suitable mortgage product types, whether fixed, tracker, discounted or offset.

It is as important as ever that we recommend the most appropriate products for individual borrowers, dependent upon their specific needs and requirements.

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