Understanding Mortgage Interest Rates
Your mortgage interest rate is what you are being charged by the lender for borrowing their money to help you buy a property.
Your monthly mortgage payment is made up of the interest you are being charged plus normally a payment towards reducing the loan that you have actually borrowed over a certain amount of time.
How does mortgage interest work?
In most cases the interest rate you pay is based on the loan you have outstanding as opposed to the amount that you originally borrowed in the beginning.
What this means is that if like most residential mortgages, you are paying the loan off over time means that the amount of interest that you pay each month is actually reducing as each month goes by.
However with an interest only mortgage as the loan amount is never changing the amount of interest you pay remains the same.
So to calculate your monthly payment on a repayment mortgage it isn’t as simple as taking your loan and dividing that by the term to calculate your payment towards your loan plus the loan amount at a set interest rate per year like so;
£200,000 divided by 35 years (420 months) = £476.19 in capital
£200,000 at 5.42% interest = £10,840 per year divided by 12 to give £903.33 per month in interest
Expected total payment of £1379.52
The actual monthly payment for a £200,000 loan over 35 years at 5.42% is £1063.57. So speak to a professional before trying to calculate what your payments would be.
What are the types of mortgage interest rates?
There have been many different types of mortgage interest rate products over the years but the most common ones that we see now are;
Fixed Rate Mortgages
and the different Variable Rate Mortgages
Tracker Rate Mortgage
Discount Rate Mortgage
Standard Variable Rate Mortgages
Over the last few years Fixed Rate mortgages have become the norm. This has been largely driven by two factors.
The first, Fixed Rate mortgages do exactly what they say on the tin. Regardless of what happens in the marketplace your mortgage interest rate will remain the same for a set period of time and cannot change.
At the beginning of 2022 it was very common to see Fixed Rates between 1% and 2% and if this was secured for 5 years, the fact that rates are now starting at closer to 4% means absolutely nothing. Your 1%/2% remains secured so a lot of people like the security that these mortgages offer.
The second factor centres a lot around cost, Fixed Rates have been very similarly priced to variable rate mortgages if not cheaper so they also offered a good price as well as security.
In more recent months, things have returned to more what they were like after the market crash of 2008 where fixed rates were more expensive then a variable rate but this may still not put people off as security around monthly payments can be very attractive to people.
Variable Rate mortgages again are exactly what they say on the tin, rather than being guaranteed the rate itself could change depending on different market conditions and the type of Variable Rate mortgage you have.
Tracker Mortgage – Tracker mortgages “Track” or follow the Bank of England base rate. Whenever the Bank of England increases or decreases the Base Rate than your interest rate would go up or down. The mortgage products are normally a set percentage above this base rate. So with the BoE base rate at 3.5% as of right now (23/01/23) if your rate was 2% plus BoE base rate your total rate would be 5.5%. An increase of 0.5% means an increase to your rate and higher monthly payments, a decrease 0f 0.5% means a decreased rate and lower monthly payments.
Discount Mortgage – Every lender has what is known as their Standard Variable Rate (SVR), this is a reference point for lenders when it comes to lending and normally what you would move onto at the end of your mortgage deal.
However a Discount Rate is where the rate you pay is based from this but at a discount. So like a tracker mortgage follows the BoE, a discount mortgage follows the SVR.
In practical terms, if a lender had an SVR of 6.99% but offered a discount of 3.5% your mortgage interest rate would be 3.49%, if the lender increased their SVR to 7.49% your mortgage rate becomes 3.99% and so on.
Standard Variable Rate Mortgage
With a standard variable rate mortgage from the beginning you will be on the lenders SVR, whenever they decide to change this rate then your payment will also change.
With this type of mortgage you are not normally tied in so should you wish to move lender or take out a new product then you can normally do this without having to pay a penalty which some of the other products could come with.
What mortgage interest rate will I pay?
The interest rate that you end up paying will be dictated by the type of rate you choose i.e Fixed or Variable but also the mortgage lender and your employment and credit history.
There over 90 mortgage lenders in the UK and all have slightly different products and criteria so there isn’t a one size fits all for every situation
Which mortgages come with the lowest interest rates?
At the moment (January 2023) we are seeing the variable rates are offering the lowest interest rates. Whether this stays like this for the foreseeable future is impossible to say.
How often do mortgage interest rates change?
The products by mortgage lenders are constantly being changed from week to week. Something available right now in 3 days time could be took off the market for either a cheaper rate or a more expensive rate depending on what the lender is looking for and how the market is going.
With regards to the Bank of England base rate prior to 2022 the rate itself was very stable for around 8 years but there has been consecutive rate raises for the last few monetary policy meetings again just showing the rapid pace at which rates are changing.
How do lenders set mortgage interest rates?
Lenders set their mortgage rates based on how much it costs them to borrow the money plus a profit margin for themselves.
It may come as a shock to hear from some people but a lot of mortgage lenders don’t lend out their own money, they normally borrow it from another institution or market.
So the more expensive it is for them to borrow the money, the higher the interest rate. When there is a lot of uncertainty in the marketplace the cost of borrowing increases which is why we see a jump in interest rates but then as things settle down you tend to see money becomes cheaper for lenders to get hold of and they can pass that saving onto their customers
What causes changes in mortgage interest rates?
Uncertainty in the marketplace, Inflation, the cost of borrowing money is just a few factors that could make a difference.
Each individual mortgage lender also has their own reasons going on, if they need to get more money out of the door they make their rates cheaper or if they need to slow things down due to capacity or service levels you can see rates raising to manage how much business they are doing.
What happens if my mortgage rate changes?
If you have one of the mortgages where changes in interest rate can make a difference then you normally receive a notification from your lender that your rate has changed and in most cases lenders give you one months grace before the new payment kicks in the following month.
Your credit history
Your credit history can be one of the factors that determines your interest rate. A good credit history would likely lead to you having access to a wider range of rates meaning you can look for the best deal.
However if you have a poor credit history it narrows down the lenders and means that you are likely to end up with a specialist lender who would charge a higher interest rate than other mortgage lenders.
Should I fix my mortgage rate?
There is no right or wrong answer to this. As mentioned further down there are numerous different factors that have to be considered and it’s not just enough to think “interest rates are going up, I must fix”
What happens if you have life changes going on in the future that could make a difference or cause you problems if you were to fix in again? or vice versa not fix in
The best thing to do would be to talk to a mortgage advisor and talk about your situation, whats going on in the future, what your goals are and worries are and you can come up with a good plan about what is right for you to do.
Can I sell my house during a fixed-rate mortgage?
You can still sell your property if you are within a fixed rate but if you decide to pay your mortgage off as opposed to take it to your next property then you would normally pay what is called an Early Repayment Charge. This is because you are coming out of your product before its due date which could cost the lender money.
Is now the right time to fix my mortgage?
There is no such thing as the right time or the wrong time to choose to fix your mortgage. There are a number of different things that have to be considered. This includes things such as what your plans are for the future such as when you want to move house again, careers changes/advancements, children etc
There is also the need to factor in your own anticipation with interest rates, nobody can predict the future, including mortgage brokers so your opinion is important. If you think rates may be increasing and you have changes you may look to fix your mortgage however if you think rates are going to decrease and get cheaper in the future you may hold off fixing until that point to give you more flexibility
Whichever option you choose comes with it’s own risks, you just have to be comfortable with your own decision being the right one for you right now.
What does negative interest rate mean for a mortgage?
Most mortgages come with what is known as a “Collar” built into them where if you are on a variable rate mortgage if interest rates were to go negative it wouldn’t mean that the lender would start paying you interest.
Most collars may be at 0% or 0.10% which just means that that no matter what happens you will never pay less than 0/0.1% in interest.
A collar is just a way for a lender to protect themselves in situations such as negative interest rates
What happens when my fixed-rate mortgage ends?
When you come to the end of your fixed rate product you have a couple of options;
Do nothing at all and move onto what is known as the Standard Variable Rate set by the mortgage lender, your payments will likely increase but you are no longer tied in and can move to a different provider whenever you like
Look at remortgaging – This is where you would look at the marketplace again and see if there are any better deals available and if you, you may choose to move mortgage lenders and take out a new product
Product Transfer – Normally around 6 months before your fixed rate ends your mortgage lender will get in touch and let you know and give you some options of some new products, you could then choose one of these new products to kick in when your current fixed rate ends. Beware however, your current mortgage lender will only tell you about their products and you won’t know how these compare to the wider market without first looking
Adjustable-Rate Mortgages (ARMs)
ARMs are mortgages more specific to the United States (USA) and something that we don’t come across in the UK.