Trackers offer a good alternative to fixed and variable-rate options, writes Laura Slattery

Torn between choosing a fixed-rate or a variable-rate mortgage? Tracker mortgages, which guarantee to fix interest rates at a set percentage above the European Central Bank (ECB) rate, are often a smart compromise between the two, according to mortgage advisers.

Tracker mortgages are a relatively new product on the Irish market, first introduced by Bank of Scotland in 2001. Last week, ICS Building Society became the latest Irish lender to offer a tracker mortgage.

"One of the best products to come into the mortgage market for many years" is how Mr Liam Ferguson of mortgage brokers Ferguson and Associates describes this type of mortgage.

"They're a very good product because they're very transparent," agrees Ms Sarah Wellband, associate director of REA Mortgage Services.

"It's easy to compare who has the best two-year fixed rate, that's a simple mathematical exercise," Mr Ferguson says. "But one of the most common questions I get asked is 'we know how it is for two years, but what sort of value do they offer in the long-term?' Tracker mortgages eliminate that problem."

Trackers can be a halfway house between traditional fixed-rate and variable-rate mortgages. They are a type of variable-rate mortgage, in that they are available over 20, 25 and 30-year repayment terms and the amount of interest homeowners pay can go up as well as down.

But any rate changes are directly tied to the cost of funds, not subject to the whim of individual lenders. Rate decreases - or increases - by the ECB must be passed on within a fixed period, usually five business days. "It puts a degree of certainty into the transaction," says Mr Michael Dowling of Sullivan Dowling and president of the Independent Mortgage Advisers Federation. "You don't have to wonder 'is the bank going to pass on the rate decrease?' "

Banks and building societies sometimes delay passing on ECB rate cuts to their standard variable-rate customers or fail to pass on the cut in full. Last December, both AIB and Ulster Bank chose to pass on just 0.4 per cent of the ECB's half-point rate cut. "Effectively they kept the other 0.1 per cent for themselves," says Mr Ferguson.

Tracker mortgages can be "a good alternative" to the standard variable rate, Ms Wellband believes. Instead of opting for a fixed-rate straight off, homebuyers could opt for the standard variable rate, then move into the tracker rate later during periods of uncertainty. That way, "you're not making a cast-in-stone decision in year one". Another advantage over fixed rates is that there are no penalties for part payment during the term of the mortgage.

The most important feature of tracker mortgages is the nominated percentage above the ECB rate at which interest is fixed. The lowest is available from Ulster Bank, making its tracker the cheapest.

Ulster Bank's Flexible Home Loan offers a percentage rate fixed at 0.95 per cent above the ECB rate for customers with a loan-to-value (LTV) ratio of less than 60 per cent (i.e. the amount owed on the property is less than 60 per cent of its market value). If the LTV ratio is between 60 and 92 per cent (the maximum that will be advanced by most lending institutions), the margin is fixed at 1.15 per cent. A further 0.1 discount is available for U First current account customers. Even on the higher margin, customers of Ulster Bank's Flexible Home Loan are currently on a variable interest rate of 3.9 per cent - 1.15 per cent above the present ECB rate of 2.75 per cent. That compares favourably to its standard variable rate, which is now 4.2 per cent.

On the other hand, AIB customers with an LTV ratio above 60 per cent are currently doing better under its standard variable rate. That could change if the ECB makes another rate cut this year. In theory, the bank could choose not to pass the reduction on in full to its standard variable-rate customers but it would have to pass it on to its tracker mortgage customers.

The table shows that three of the six tracker mortgage providers currently have more competitive rates on these mortgages than they do on their standard variable rate, while a further two offer better deals if LTV ratios are below 60 per cent.

The newest arrival to the tracker mortgage market, ICS's product, is also the most expensive. It guarantees to fix interest rates at 1.45 per cent above the ECB rate, although there is a discount in year one. That means anyone signing up for it now will be given a rate of 3.44 per cent for the first year, but after that will revert to 4.2 per cent - the same interest payable on its standard variable-rate mortgage.

"The ICS tracker is not particularly competitive," says Ms Wellband. "It's the same as the standard variable rate. I don't see why they didn't shade it a little bit." Higher margins detract from the advantage of being on a tracker mortgage, she adds.

With fixed-rate mortgages, cheapest is not necessarily best. Homeowners sometimes find when they reach the end of their term that a new fixed contract could prove a lot more expensive or the lender might not have such a competitive standard variable rate.

The same is not true for tracker mortgages, Mr Ferguson notes. "I would have to question why would anyone who is going for a tracker not go for the lowest rate tracker?"

At most lenders it is possible for standard variable-rate customers to switch to their ECB tracker mortgage. "It's a case of writing in and asking for it," says Mr Ferguson.

However, that's provided the lender offers a tracker mortgage product: about half the lenders operating in the Irish market don't bother with them at all.

Their desire to maintain profit margins is the reason why, according to Mr Dowling. "Banks have a better margin on the three, four and five-year fixed-term mortgages than they do on trackers," he explains. "Banks get their profit margin from the difference between what it costs them to borrow and what it charges to customers. If everybody took a tracker mortgage, it would affect the bottom line at the bank."

So if tracker mortgages are such a good idea from homeowners' point of view, why isn't everyone piling into them?

Firstly, people who have been paying their mortgage off for a number of years may not be aware that their lender offers tracker mortgages. Some lenders, such as AIB, only introduced them quite recently and do not market them in their own right.

Secondly, first-time buyers will still opt for the security of a fixed-rate mortgage for the initial two or three years, when even a minor upward adjustment in rates could make repayments unaffordable.

"Rates are so low at the moment, people are looking for fixed rates. If interest rates go up, the tracker mortgage will go up," says Mr Ferguson. "People are choosing to fix now because they believe rates couldn't get any lower, whether that's true or not."