RLA : RPI : How to choose between a fixed, discounted or tracker rate

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other artilces from the December 03 / January 04 issue

How to choose between a fixed, discounted or tracker rate - December 2003 / January 2004

Pierre-Jean Stracuzzi of The Buy-to-Let Company

There are more or less 680 buy to let mortgage products and rates offered in the UK to landlords at any time.

As of mid November they fell into six broad categories: fixed rate, capped, discounted, tracker, Libor linked, and variable. The three most numerous types of offer were tracker, fixed and discounted schemes, in that order.

This leaves landlords with both a choice and a dilemma which of the near 700 options to choose?

Fixed rate mortgages offer landlords the certainty that allows them to budget monthly mortgage costs precisely for a certain period of time. In return landlords forego the opportunity to reduce monthly mortgage costs should interest rates come down during the period.

Fixed rate mortgages will also, more likely than not, include early redemption penalties covering the fixed rate period sometimes extending after the period (for a 'further tie-in' or 'extended tie-in').

Capped rates give borrowers a guarantee that the interest rate will not go higher than the cap, but can come down should interest rates drop below a certain level. The advantage of this type of product is the certainty from day one that upper limits have been set, but things could get better if interest rates come down.

Sometimes 'cap and collar' mortgages are offered, imposing a minimum payment rate (the collar) in addition to a maximum rate (the cap).

Again, most often capped rate mortgages will include early redemption penalties should the borrower wish to redeem the mortgage during the capped rate period and sometimes for some period after.

Variable rate mortgage offers, including discounted, tracker, and Libor linked, are by far the most numerous.

The variable rate does exactly what it says on the tin: it varies up and down. So at one point in time, it could be cheap and other times it could be much dearer. A change in rate may result in significant changes to the borrower's monthly payments, so when considering a variable rate mortgage it is advisable to leave enough room in the budget to allow for possible increases. Typical variable rate mortgages do not include early redemption penalties.

Tracker mortgages are variable rate mortgages that tend to track the Bank of England Base Rate.

Discounted schemes move up and down with interest rate changes but start and remain at a lower, discount rate for an agreed period.

Libor linked rates follow the London Inter Bank Offered Rate that at which banks lend money to each other. Libor changes daily although Libor linked mortgages will normally be adjusted every three months. Libor linked rates are usually quoted as a given percentage above Libor.

In the case of each type of these specialised variable rate mortgages it is true to say that the keener the rate offered, the more chance there is of early redemption penalties being attached to them.

The pros and cons of each type of mortgage should be considered, taking into account the strategy for the property against which the loan is to be set for example, how long will it be kept (months, years or decades)?

Landlords will also have to take some view of the state of the economy and the lettings market. Are interest rates more likely to go up or down, and by how much? Is it likely that rental yields will change dramatically and are letting voids likely?

Few forecasts turn out to be correct in every respect, but the important thing is to make a reasoned decision that leaves some flexibility should things turn out to be not so beneficial as anticipated.

other artilces from the December 2003 / January 2004 issue

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