One of the critical features of your mortgage is the rate at which you pay interest on the loan. The rate can vary widely – and, in so doing, make the difference between a mortgage payment where you are having to spend or are able to save many thousands of pounds over the life of the mortgage.
Mortgage interest rates are determined in several different ways and probably the most common is the so-called standard variable rate. What does the term mean and is it likely to be the appropriate mortgage for your own needs and financial situation?
What is a standard variable rate mortgage?
A standard variable rate mortgage provides the basic model on which mortgage lenders advance their loans. Some people may refer to it as an adjustable rate mortgage.
It is a standard rate because that is the baseline to which the lender’s practices will always return in the absence of some other rate of interest – it is their default rate of interest, in other words. In the words of the Money Advice Service, it is the “normal” rate of interest which any lender charges a homebuyer for their mortgage – unless a different type of mortgage is arranged.
It is a variable rate because it may vary over time, according to decisions made by the mortgage lender. Each lender may have a different standard variable rate and those rates may change independently from one lender to another.
For many borrowers, the mortgage lender’s standard variable rate (or SVR as it is often known) is the default rate of interest to which they will be transferred when a fixed-rate mortgage, a tracker mortgage or a discounted mortgage comes to an end.
For that reason, a standard variable rate mortgage is also sometimes known as a reversion-rate mortgage, explains a guide published by Which? magazine in April 2020.
How does a standard variable rate mortgage work?
To understand how a standard variable rate mortgage works, it might be helpful to remind ourselves of the principles behind your home loan monthly payment.
Part of what you pay goes towards repayment of the capital amount you borrowed; part of it pays the interest on the outstanding mortgage balance (what you continue to owe).
If the interest rate changes – as a standard variable mortgage rate is going to do – then your monthly payment must increase to cover that higher rate of interest, even though you are not reducing the outstanding balance of your mortgage.
The mortgage loan lender decides when and by how much it is going to increase or lower the rate of interest. Typically, it does so after there has been some change in the Bank of England’s base rate – and it might be worth reviewing the Bank’s explanation of interest rates in general and its role in setting the base rate.
Changes in the base rate, however, only give a broad indication of your lender’s setting of its standard variable rate of interest. There may be a delay before the lender responds, for example, or the lender may decide upon a reduction or increase in the rate that is different from any change in the base rate.
Unlike a tracker mortgage, for instance, the standard variable rate does not exactly shadow movements in the Bank of England base rate.
What is better – a fixed rate or variable rate mortgage?
The reason why this is a difficult question to answer is because it all depends on the fixed rate you are offered, for how long that deal lasts, and how your particular mortgage lender varies its standard variable rate.
In recent years, of course, the Bank of England’s base rate has steadily fallen (to an all-time low) so, it might be argued that you might be better off with a variable rate mortgage.
But it remains a gamble. The Bank of England base rate or the average variable rate charged by mortgage home loan lenders may still go up or down and, depending on the fixed rate of interest you were offered, you may end up being relatively worse – or better – off.
A story in the Express newspaper on the 22nd of August 2020, for example, revealed that the average standard variable rate (SVR) mortgage in July 2020 was 4.46%. At the same time, a fixed-rate mortgage arranged in 2018 attracted an average rate of interest of just 2.52%. So, when that fixed rate mortgage deal came to an end in July 2020, borrowers would have faced an unwelcome 2% jump in the interest rate they had to pay once they reverted to the lender’s standard variable rate.
What are the pros and cons of a variable rate mortgage?
This reasoning helps to explain some of the pros and cons of a variable rate mortgage. If you are prepared to take the risk on interest rates staying the same or falling, then your monthly payment for your mortgage may be lower than if you were on a fixed rate mortgage deal.
Mortgage lenders are aware that you are taking such a risk – so, may be prepared to offer a lower rate of interest on a standard variable rate than it is at that time prepared to offer on a fixed-rate deal.
In practice, of course, it will remain exceedingly difficult to predict whether an average mortgage rate will be falling or rising – you must bear the risk of the potentially significant financial consequences of such a movement.
Why do some variable mortgages have a ‘collar’?
To protect yourself against especially big increases in a mortgage rate, you might opt for a variable-rate mortgage that has a built-in “cap”. With this, the lender sets a maximum rate of interest above which your mortgage will not rise.
The flip-side of that coin is described by the Money Saving Expert in a posting dated the 15th of September 2020.
This explains how mortgage lenders, too, have sought to reduce the risks to which they may be exposed through a falling average mortgage rate. It gave the example of a massive movement in the Bank of England base rate from 5.75% down to just 0.5% in the period between July 2008 and March 2010.
Without a “collar” to define the minimum interest rate to which mortgages could fall, lenders could have been hit by considerable losses as rates did indeed drop so spectacularly.
If you opt for a standard variable rate mortgage, therefore, you might want to establish whether the lender offers either an interest rate cap (on the maximum rate you might pay) or impose a collar (on the minimum rate of interest you pay).
Because standard variable rate mortgages have both their pros and cons, it may make sense to discuss your home loan options with a mortgage broker. They have the expertise to help you make the most appropriate decision for you.