Mortgage interest rates can be difficult to understand, but you must know how they work, as this will help you when it comes to taking out a mortgage yourself. Here, we share information about mortgage interest rates, how they’re worked out, and what the different types are.
What is a mortgage interest rate?
Your mortgage interest rate is a percentage of the loan you’ve taken which you pay the mortgage company in exchange for lending you money for your property. A low-interest rate means that you won’t need to pay the lender as much, whereas a high-interest rate can get pricey – especially if you’ve borrowed a large amount. If you have a repayment mortgage, you’ll pay off an amount of your loan plus interest each month. If you have an interest only mortgage, you’ll only pay off the interest each month.
How do lenders work out interest rates?
There are several different elements involved when it comes to how lenders work out what your interest rate should be. Firstly, they’ll work out a representative rate – which is the one you’ll typically see being advertised. This is calculated using the Bank of England’s base rate and the London Interbank Offered Rate. These figures will be combined with knowledge about other factors, such as the current unemployment and repossession rates, as this helps to determine how risky it is to lend. The interest rates that their competitors are charging will also come into play so be mindful of this too.
The representative rate won’t necessarily be the one that you’re offered as your circumstances will also be taken into consideration. For example, whether you have a good credit history and the size of your deposit. Your credit history helps lenders to decide how much of a risk you are, whereas your deposit size determines your loan-to-value ratio. The lower this is, the less risky you are and the less risky you are the lower the interest rates you’ll be offered. As a rule of thumb, lenders consider anything below an 80% LTV to be low risk, but this will depend on other factors too.
What are the different types of mortgage interest rates?
There are two different types of mortgage interest rates to look out for: fixed rate and variable rate.
A fixed-rate mortgage is agreed at the start of your mortgage term and stays the same for the duration. You can choose the number of years that you fix your mortgage for, and the most common options are two, five, or ten years. A fixed-rate mortgage will give you peace of mind that your interest rate won’t rise, regardless of what’s happening in the market, but this could also mean that you miss out on a lower interest rate if it should drop. If you take on a fixed rate mortgage and want to leave it before the end of the agreed term, you’ll usually pay an early exit fee – the cost of which will be dependent on how long you have left of your mortgage term.
When you opt for a variable rate mortgage the interest rate can change at any time, which may not be a good choice for you if you are unable to afford your monthly payments should they rise. However, this option does offer flexibility as you can leave at any time, so you’re not tied into a deal like you are with a fixed-rate mortgage. A lender’s standard variable rate (SVR) is one that they implement themselves. Alternatively, you could opt for a tracker mortgage which tracks the Bank of England base rate to determine how much interest you pay. The rate will typically be 0.5-2% higher than the base rate.
Finding the right mortgage can be confusing, especially if you haven’t done it before. This is when seeking help from a mortgage advisor is useful as they can provide you with all of the information you need and can ensure that you opt for the right solution. If you’re looking to take out a mortgage, contact our knowledgeable team today who will offer you independent mortgage advice.