Interest rates could fall to 2.75%: Should you take a tracker mortgage?

Interest rates are on a downward trajectory, leaving mortgage borrowers approaching the end of their current deal with a decision to make.

The majority of mortgaged households are on fixed rates, with most tending to choose between either a two-year fix or a five-year fix.

Of the 7.1 million households currently on fixed rate deals, around 1.6 million need to switch to a new rate over the course of this year, according to UK Finance.

There are also some 540,000 borrowers sitting on their lender's standard variable rate. This is the rate that people end up on once their fixed deal ends and they fail to switch to a new one.

There are also 591,000 households on tracker mortgages. These essentially track the Bank of England base rate, plus a percentage. For example, base rate (4.25 per cent) plus 0.5 per cent giving an overall rate of 4.75 per cent.

Tracker mortgages are popular because some come without early repayment charges and can therefore be paid off or switched away from without penalty.

There is also potentially a growing case for choosing a tracker mortgage given that interest rates are widely expected to fall further over the coming 12 months.

Yesterday, the Bank of England cut interest rates for the fourth time since August last year.

Markets are currently forecasting a further three 0.25 percentage point cuts by the central bank before the end of the year. This could mean interest rates reach 3.5 per cent by Christmas.

This is a market consensus shared by many, although there are some that think base rate may be cut even further or faster than that.

Analysts at Morgan Stanley are predicting UK interest rates will reach 3.25 per cent by the end of the year.

The US bank forecasts the Bank of England will keep cutting interest rates through the early months of next year with interest rates settling at 2.75 per cent in the first half of 2026 where they think it will stay for the foreseeable future.

Morgan Stanley analysts think the UK economy will struggle this year forcing the Bank of England to take action and cut rates more aggressively.

They argue lower GDP growth will be exacerbated by a slowdown in household disposable incomes.

Meanwhile, economists at Oxford Economics are predicting that base rate will eventually fall to 2.5 per cent in 2027 where they think it will remain throughout 2028 and 2029.

They believe interest rates will fall to 3.75 per cent by December this year, then to 3 per cent next year and then to 2.5 per cent in 2027.

Currently, tracker mortgages are more expensive than fixed rate deals, so borrowers will have to forfeit short-term savings in the hope of bigger future savings - and this is of course is by no means guaranteed.

The lowest five-year and two-year fixed rates for someone remortgaging are now both at 3.84 per cent, offered by Nationwide Building Society, albeit it comes with a £1,495 fee.

This is available to households remortgaging with at least 40 per cent equity in their home.

Someone locking in a £200,000 mortgage on a 25 year repayment term could expect to pay £1,038 a month with the Nationwide deal, not including the £1,495 fee.

In terms of the best tracker deals for those remortgaging with at least 40 per cent equity, Santander is currently offering a two-year deal at 4.35 per cent deal (base rate plus 0.1 per cent). The deal does come with a £1,058 fee, but there are no early repayment charges.

Someone with a £200,000 mortgage and a 25 year repayment term would expect to be paying £1,095 a month with Santander to start with.

But of course, were interest rates to fall to 3.25 per cent by the end of the year, the interest rate would fall to 3.35 per cent and monthly payments to £985.

If Morgan Stanley's analysts are correct and rates fall to 2.75 per cent in the first half of next year, then by June the situation could be even better.

The mortgage rate will have fallen to 2.85 per cent and the monthly payments to £933.

If this were to happen, the fixed rate mortgages available may also be lower, allowing someone to then lock in at rates lower than they are today.

However, this all relies on forecasts turning out correctly. All manner of things can blow forecasts apart; resurgent inflation, trade tariffs and recessions to name a few.

Forecasts should also always be taken with a pinch of salt.

After all, at the beginning of last year, markets were predicting six or seven interest rate cuts in 2024. There were only two in the end.

'Trackers are worth considering,' says Chris Sykes, a property finance specialist. 'However, fixed rates are still by far the most popular choice.

'Trackers are generally coming in at a premium of around 0.5-0.75 per cent at the moment versus comparable two-year fixed rates.

'The questions on everyone's mind is when would that tracker go below the fixed rate, and would it go soon enough to effectively profit from the tracker.

'If it takes six months for base to drop 0.5-0.75 per cent then you will have paid a premium for six months, then you need it to drop below for you to work your way into profit.'

Ultimately, it could be a gamble worth taking, particularly for those who like the added flexibility of being able to change mortgage product or repay early without penalty charges.

Aaron Strutt, of broker Trinity Financial, said: 'Most borrowers tend to take a tracker rate when they want a flexible mortgage without any early repayment charges, often because they do not want to be tied in due to the sale of their property, or an upcoming change in their finances, work location or living arrangements.

'Halifax has a two-year rate that tracks the base rate plus 0.11 per cent, and while it does have a £1499 arrangement fee, it does not have any early repayment charges.

'Santander's two year tracker is 0.1 per cent over the base rate for mortgages up to £1.5 million and it does not have any early exit penalties either.'

Mortgage rates have risen substantially over recent years, meaning that those remortgaging or buying a home face higher costs.

That makes it even more important to search out the best possible rate for you and get good mortgage advice.

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