Is a Tracker Mortgage the Same as a Variable Mortgage?
Are all variable mortgages the same? Understand the key distinctions between general variable rates and specific tracker mortgages.
Many individuals encounter terms like “variable rate mortgage” and “tracker mortgage,” often assuming they refer to the same financial product. Understanding the distinctions between these mortgage types is important for making informed decisions about home financing.
Understanding Variable Rate Mortgages
A variable rate mortgage, commonly known as an Adjustable-Rate Mortgage (ARM) in the United States, features an interest rate that can change over the loan’s term. These mortgages typically begin with an initial fixed-rate period, which can range from a few months to several years.
After this introductory period, the interest rate becomes subject to periodic adjustments, meaning monthly payments can increase or decrease. The adjustments are generally tied to a specific financial index, such as the Secured Overnight Financing Rate (SOFR) or a U.S. Treasury Index, plus a predetermined margin set by the lender.
While the rate movements are influenced by these market benchmarks, the lender retains some discretion in setting the margin and implementing rate changes. Many variable rate mortgages incorporate rate caps, which limit how much the interest rate can increase during an adjustment period and over the entire life of the loan, offering a degree of payment protection.
Understanding Tracker Mortgages
A tracker mortgage represents a specific category within variable rate mortgages, distinguished by its direct and transparent link to an external benchmark interest rate. In the United States, a common benchmark for such mortgages is the Secured Overnight Financing Rate (SOFR).
This rate is published daily by the Federal Reserve Bank of New York and reflects the cost of borrowing cash overnight, secured by U.S. Treasury securities. The interest rate on a tracker mortgage is determined by adding a fixed margin or spread to this publicly available benchmark rate.
When the benchmark rate changes, the mortgage interest rate automatically adjusts by the same amount, without any additional discretionary decision by the lender. This direct correlation provides a clear and predictable mechanism for rate changes.
Comparing Variable and Tracker Mortgages
While both variable and tracker mortgages involve fluctuating interest rates, their fundamental mechanisms for rate adjustment differ. A tracker mortgage is, by definition, a specific type of variable rate mortgage, but not all variable rate mortgages operate as trackers.
The defining characteristic of a tracker mortgage is its explicit and automatic adherence to a specified, public benchmark index. General variable rate mortgages, while often influenced by market indices, typically allow lenders more flexibility and discretion in how and when they adjust the interest rate.
This can lead to less immediate and direct correlation with public benchmarks compared to tracker mortgages. Both mortgage types expose borrowers to the possibility of increased payments if interest rates rise, but they also offer the potential for reduced payments if rates decline.