Fixed or Tracker, that is the question?

Lenders have pushed up the cost of their fixed-rate deals this year and cut the cost of trackers in preparation for an interest rate rise.

Borrowers are flocking to fixed-rate mortgages to lock in today’s record-low interest rates – but many could be thousands of pounds better off with a tracker mortgage, even as a rate rise looms.

Research undertaken by The Telegraph shows that over five years, trackers, which move in line with Bank Rate, could be significantly cheaper than a fixed rate if interest rates rise slowly, as predicted.

This is because lenders have pushed up the cost of their fixed-rate deals this year and cut the cost of trackers in preparation for a rate rise. Borrowers are being asked to pay a growing premium for the security of a five-year fix. By contrast, two and three-year deals are still cheaper than tracker mortgages.

Judging whether to fix your mortgage repayments or track interest rates hinges on how willing you are to gamble with a variable rate and your ability to meet repayments if they increase faster than expected. The sooner and faster the Bank of England increases interest rates, the more likely a fixed deal will offer better value – and vice versa.

Last month, Mark Carney, the Governor of the Bank of England, said rates could rise to between 2.5pc and 3pc in the three years to 2017. The Bank has said it expects rates to remain at this level for some time beyond 2017.

Market expectations for Bank Rate indicate it will initially rise to 0.75pc in the early summer of next year and by the same amount again in the autumn to 1pc.

The Telegraph has modelled three scenarios with mortgage broker London?&?Country to show what could happen to the cost of five-year tracker deals if Bank Rate rose slowly, moderately and quickly based on these expectations.

It compares the best five-year fix, currently HSBC’s 2.94pc loan with a £1,499 fee, with the best tracker, also from HSBC and charging 1.49pc above Bank Rate (1.99pc) with a £999 fee.

A number of assumptions have been made, including that Bank Rate will rise in 0.25 percentage point increments.

The slowest rise assumed Bank Rate would not rise until November 2015 when it would increase to 0.75pc. It would then rise every nine months, meaning interest rates would be 1.75pc in April 2019. In this scenario the total cost of the tracker mortgage would be £54,414 – more than £3,600 cheaper than the fix at £58,031.

The moderate rate rise assumed the first increase would occur in April 2015, with subsequent rises every six months. This would put Bank Rate at 2.5pc in April 2019. In this scenario the tracker would cost £56,862, still £1,169 cheaper than the fix.

Only the fastest rise, which assumed the first increase would happen in October this year with subsequent increases every four months, put the fix ahead. In this scenario Bank Rate would reach 3pc in April 2019 and the total cost of the tracker would be £60,294, £2,263 more than the fixed.

While interest rates may not follow any of these patterns exactly, it shows tracker deals should not be discounted.

Mark Harris, chief executive of mortgage broker SPF Private Clients, said he believed rates would not rise above 2pc in the next five years. He said the economy was still in a state of recovery and couldn’t yet cope with sustained rate rises. He said borrowers who had financial flexibility should consider a tracker. “They could be the cheaper option over five years. But 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.”

What is apparent is that borrowers should make a decision either way – the cost of being on a lender’s standard variable rate could add more than £20,000 to the repayments over five years.

If rates rise in line with our fastest scenario, borrowers on a standard variable rate of 4.29pc above Bank Rate (4.79pc) could pay £78,697 over the five years.

The average two-year fix rose from a low of 3.52pc in January to 3.65pc this month, according to research by Moneyfacts.co.uk. The average three-year fix followed the same pattern, rising from a low of 3.83pc in January to 3.97pc this month. Five-year fixed deals, which hit record lows in August with an average of 3.83pc, have now risen to 4.04pc.

The average tracker rate, on the other hand, has fallen to a record low of 2.29pc above Bank Rate (2.79pc).

As the margins widen between the two options, borrowers face a dilemma, and many will stick with a fixed rate.

For those struggling to decide, it makes sense to stress test your own monthly budget to see what impact a rising variable rate could have on your payment. Once you have done this, discuss your findings with an independent mortgage broker, who will be able to advise you on the best way forward.