Mortgage guide

A tracker mortgage differs from a variable rate mortgage in that the interest rate tracks the bank base rate set monthly by the Bank of England. This means that all cuts in base rates are automatically passed on to the borrower (this often doesn't happen with variable rates although, unsurprisingly, any increases are swiftly passed on).

The margin between pay rates and base rate is usually smaller on a tracker than on an ordinary variable rate and it remains constant for a set period or the whole term. So with this type of mortgage you are not as vulnerable to decisions made by your lender as you are with other methods of charging interest.

A tracker mortgage can range from 0.5 per cent to 2.0 per cent above base rate and it will be set for the agreed period. This has plenty of advantages. When the Bank of England announces its monthly decision on base rates you can work out immediately what your pay rate will be - you don't have to wait to see what your lender will do because it has promised to follow the rate. And you will benefit from all cuts in base rate, no matter how low they go.

However, there is one disadvantage to tracker mortgages. If interest rates were to rise steeply, so too would the cost of a tracker. In that situation you would have been better off in the short term getting a fixed or capped rate.

Trackers work better when interest rates are falling but in the long term they give you clear value whatever the Bank of England does with rates.

Also, it is now possible to get fixed or capped or discounted rate trackers which simply revert to the tracker after the initial lower interest period ends. The best of both worlds.

Many borrowers like the idea of tracker mortgages because of their transparency and the fact that the decisions on interest are ready-made. It seems as though their mortgage repayments are in the hands of the Bank of England rather than their lender.

And it's good news for lenders too as they are guaranteed the same margin no matter what happens to interest rates. With a standard variable rate they may have to cut their profit margin (very slightly) to maintain their competitive edge.

With a tracker both the consumer and the lender know exactly what they are getting - the only factor that you can't control is the Bank of England's Monetary Policy Committee.

Flexible Mortgages
With a flexible mortgage, borrowers can overpay, underpay, take payment holidays, borrow back funds and benefit from daily interest calculation, which can save thousands of pounds and knock many years off the mortgage term. All with no redemption penalties. More on flexible mortgages.

Check the APR
Whichever kind of mortgage you go for check out the APR - annual percentage rate of the various mortgages you are considering. This will help you compare. Generally, the lower the APR the cheaper the mortgage. But beware if it is a low-start rate then it will certainly increase once that initial period is up. So it is worth checking the "standard variable rate" - the standard rate the mortgage company charges and find out how competitive that is. It is no good getting a cheap rate for two years followed by an expensive rate for the next 23. And you may find that you can't switch to a cheaper mortgage because of redemption penalties.

Redemption penalties
Fixed, capped and discounted mortgages are likely to carry penalties for stopping or changing the loan in the middle of its term. The cost may be as much as six months' interest payments.

These redemption penalties can be longer than the life of the special period. For example, a five-year fix may require you to borrow for a further two years at the bank or society's standard variable rate before you are able to move without penalty charges.

Whatever kind of mortgage you are looking for you should always ask about redemption penalties and check the small print.

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