Targeting a tracker mortgage could pay dividends

Interest rates will not exceed a set percentage above the ECB base rate,writes Laura Slattery

The new breed of tracker mortgages promises to bring cheaper home loans to borrowers, all with in-built guarantees that interest rates will not exceed a set percentage above the European Central Bank (ECB) base rate.

But not every consumer will be able to benefit from these new competitively priced tracker mortgages - or, at least, not without either asking for them or remortgaging.

Tracker mortgages "track" the ECB base rate of interest - the rate at which it costs the lender to borrow money - and add a fixed margin to the rate.

This margin is the lender's profit on the loan.

Tracker mortgages are a relatively new product to the Irish market, first introduced by Bank of Scotland in 2001.

This time last year, just six lenders offered tracker mortgages and many did not market them in their own right.

Walk into any branch of most banks and building societies and information on tracker mortgages will have been scant to non-existent.

But during 2003, lenders' hesitancy in passing on ECB rate cuts to standard variable rate customers proved just how attractive tracker mortgages could be.

Borrowers have the certainty of knowing that the interest they pay will be tied to the cost of funds rather than the whims of the lenders.

And unlike a fixed-rate loan, trackers allow lump sum overpayments without charging a penalty.

Now only Irish Nationwide and EBS Building Society do not offer tracker mortgages: IIB Homeloans, First Active and Permanent TSB have all joined the fray, while AIB and Bank of Ireland have both narrowed the margin on theirs.

At the moment, all lenders in the market have a smaller profit margin (and thus a lower interest rate) on their tracker mortgage than they do on their standard variable rate mortgage.

"We are certainly going to see the demise of the standard variable rate and the growth of these more attractive tracker rates at competitive levels," says Mr Michael Dowling of Sullivan Dowling property consultants.

So if the case in favour of trackers is so clear cut, why do lenders still bother offering obviously more expensive standard variable rates?

Why is the standard variable rate still the most common rate for existing borrowers to be on?

First of all, some new borrowers will be told that their mortgage is not quite big enough to qualify for the tracker rates.

First Active's tracker mortgage offers several different rates depending on the value of the loan in relation to the property price, known as the loan-to-value ratio (LTV).

But in all cases, customers will only qualify for the tracker rate if they borrow €250,000 or more.

Meanwhile, Permanent TSB has two rates according to the size of the loan: the more you borrow, the less interest you will be charged, but the lowest amount on which it will advance a tracker mortgage rate is €150,000. "Logically, you could say there is a bit of discrimination there if the rate is relating to the loan amount rather than the loan value," says Mr Dowling, who is president of the Independent Mortgage Advisers Federation (IMAF).

But other lenders only set their tracker rates according to LTV. The higher the deposit customers can raise for their property, the less risky a proposition they are for a lender, so they will be rewarded with a better rate.

"That's where competition comes into play," notes Mr Dowling.

If your mortgage is more than €250,000 but with a 92 per cent LTV, then AIB and Permanent TSB will both offer you a rate of 3.1 per cent.

This is the most competitive rate available in its own right, but if you are a U-First current account holder, you will be able to secure a rate of 3.05 per cent for the same loan at Ulster Bank.

If your 92 per cent LTV mortgage is less than €250,000, however, AIB becomes more competitive than Permanent TSB.

In fact, both AIB's standard variable rate of 3 per cent and EBS's standard variable rate of 3.35 per cent beats some of the trackers on offer elsewhere.

With loans of all sizes less than 60 per cent of the property value, Ulster Bank and AIB have the most competitive rate at 2.95 per cent, although First Active will be better value for large mortgages with very small LTVs.

Again, if you open a U-First current account, Ulster Bank's Flexible Home Loan will be cheaper, offering a rate of 2.85 per cent.

Only three of the nine lenders in the tracker market offer the same rate to all size and value loans.

This suggests that trackers will herald an era of tiered interest rates, where the less attractive a customer you are, the more interest you will be charged.

As is often the case with the best personal finance deals, potential borrowers may need to be clued in to what's available before they can get it.

"I would hope that a first-time buyer [going directly to a lender] would automatically be steered towards the tracker rates," says Ms Sarah Wellband, adviser at mortgage intermediary REA.

"I would suspect that many are still being 'seduced' by the one-year discount or fixed rate, which then go to a higher standard variable rate," she says.

Crucially, a number of lenders, including Bank of Ireland, Permanent TBS and First Active, are only offering tracker rates to new customers.

Unlike discount fixed rates, the tracker rate will last for the life of the loan.

But their vast profitable base of existing customers would have to remortgage in order to get the cheaper loans.

"Lenders are going to come under pressure from existing customers who will say there is no reason why they should be discriminated against," says Mr Dowling.

While many people will feel that existing customers should be rewarded for their loyalty, at the moment the pattern is that "as soon as you become a customer, you become less valued than a potential customer", he says.

Existing mortgage holders can bang on the table and demand the lower rate, he adds, or failing that, move their loan to Ulster Bank under the free remortgaging service it introduced at the start of 2004.

Mr Liam Ferguson of mortgage and insurance intermediary Ferguson & Associates believes that lenders which only allow new customers to avail of trackers are adopting an odd stance given they can now switch to Ulster Bank's tracker at no cost.

"But perhaps the old friend of the banks - customer inertia - will keep the numbers of people actually doing this low enough not to bother them," he adds.