When selecting a mortgage, it’s important to look at more than just the monthly repayments and to understand how much the interest rate payments will cost you, when they might go up or down and what your repayments will be after this happens.
With the recent announcement that the Bank of England will be increasing interest rates, everyone from first-time home buyers to people looking to obtain a loan will be affected, it’s now even more important you understand this. To help we are going to explain all the different types of mortgage rates and how you’ll be affected with the current changes.
What are the different types of mortgage interest rates?
Although there are others, there are two main types of mortgage interest rates; Variable rates and Fixed rates. Let’s take a look at what these, and what other type of rates you could get:
Fixed rate
A fixed rate mortgage means the interest rate is locked for a predetermined duration, and will not change during that period whether that’s by increasing or decreasing. This also means the monthly payment will stay the same for the agreed duration.
You might see these advertised as ‘two-year fix’ or ‘five-year fix’ alongside the interest rate charged for that period of time. When this period ends, your mortgage will move to a Standard Variable Rate (SVR) unless you choose to remortgage. Your new SVR is likely to be considerably higher than what you had on your fixed rate, which will cause an increase in your monthly repayment.
Mortgage loans usually have a repayment lifespan of about 30 years, although there are shorter length loans out there of about 10, 15, 20 years. It’s important to bear in mind that fixed rate mortgages with a shorter life span will require larger monthly payments, but tend to have lower total interest costs.
Pros:
- Certainty that your monthly payments will stay the same, helping you to budget and know that your rates won’t increase if national mortgage rates go up.
Cons:
- Fixed rate deals tend to be higher than variable rate mortgages
- If interest rates fall, your rate won’t
Standard variable rate (SVR)
With variable interest rates, the rate can be changed from month to month at any time by your mortgage provider, meaning your repayments can be subject to change. Each mortgage lender will have their own SVR that they can set to whatever level they want. This rate tends to be higher than the rate you’d find on a fixed, tracker, or discount mortgage rate.
SVRs don’t change often as they’re not directly linked to a base rate (which we’ll get into in a minute) but are usually affected by it; if the bank’s base rate goes up by 0.25%, lenders don’t have to increase their SVR mortgages by the same margin, but they often will.
Pros:
- SVR mortgages usually don’t have an Early Repayment Charge, allowing you the flexibility to potentially pay off your mortgage sooner, or switch to a new mortgage deal with a better rate without being charged.
Cons:
- Your lender can change its SVR at any time, meaning your monthly payments can suddenly increase without warning.
- SVRs tend to be higher than the rates offered by other types of mortgage.
Tracker rate
A tracker rate is where the interest rate you pay is based on an external factor, usually the Bank of England base rate, plus a set percentage. Your rate might be described as a ‘base rate +2%’ for example, meaning your rate now (as of August 2022) would be 3.75%; the Bank of England’s base rate of 1.75% plus 2%. However if the base rate went up, the interest rate on your mortgage will rise also. If it decreases, you might pay less each month but this is not always how it works out.
This is because some tracker mortgages come with a ‘collar’, meaning the rate can only fall to a certain level (this is similar to a ‘cap’ when the rates can only rise to a certain rate). This means if the base rate plummets, your payments might not fall as much as you would like.
Like fixed-rate mortgages, trackers will have an introductory deal (most commonly two years) and after this you’ll be switched to your lender’s SVR if you don’t choose to remortgage.
Pros:
- The Bank of England’s base rate is the only thing that can affect your mortgage rate, so changes to your lender’s SVR will not be able to affect your monthly repayments.
Cons:
- You aren’t able to accurately predict how much your monthly repayments are going to be throughout the mortgage period as the base rate can change this.
- If your tracker mortgage has a cap, you might not benefit from a drop in the base rate.
Discounted rate
Discount mortgages are a type of variable-rate deal that will be your lender’s SVR minus a fixed margin for either a set period of time, or for the entirety of the mortgage deal. So if your lender’s SVR is 6% and your discount is -2% you’ll pay a rate of 4%.
This means if your lender’s SVR goes up, your payments will increase accordingly, but if it goes down you’ll pay less. Discount mortgages often come with an introductory deal of about two years.
How are mortgage rates calculated?
There are a variety of different factors that contribute to how a lender will set the interest rates on it’s mortgages:
Loan to value (LTV)
Typically, the larger the deposit you have, the less interest you’ll be required to pay and you’ll typically be given a lower rate. If you’re asking for a mortgage and you are able to put down a 40% deposit, you’ll qualify for much better rates than those asking for a mortgage with a 10% deposit.
This is due to how the bank qualifies the risk; if you’re borrowing at a high loan-to-value ratio then you won’t have much equity in the property (meaning you own less of the house than someone who was able to put down a higher mortgage). As a result, if you default on the loan or property values drop, the mortgage lender is more likely to make a loss.
Your credit history
Your credit report will indicate to mortgage lenders your record as a borrower, which will have a significant impact on the mortgages you may be able to get. If you’ve missed payments in the past, whether that’s on bank loans, credit cards, or just your phone bill, this will leave a mark on your credit file that indicates to future lenders that you may not be reliable in repaying bills.
Not all mortgage lenders will consider people who have marks on their credit history, and those who will lend will often charge a higher interest rate due to the increased risk.
Competition
This factor is less to do with those borrowing the money, and more about the level of competition in the market, and the mortgage lender’s own targets. If a lender wants to be a top player in the mortgage industry, they’ll be investigating how their competitors are pricing loans, and use this research to work out what interest rate they should be lending at, depending on how competitive they want to be.
It’s important to understand which companies combine great rates with top customer service to find the best lender for you.
How will the Bank of England interest rate rise affect my mortgage?
On the 4th August 2022, the Bank of England voted to raise interest rates by 0.5% from 1.25% to 1.75%. This will affect different mortgages in different ways, and affect people across the UK at different levels.
For borrowers on a fixed-rate, there will be no change to their monthly repayments or current interest rate.
But for the 25% of households on a variable rate (either a tracker mortgage or an SVR) this won’t be the case. Around 800,000 people in the UK have a tracker mortgage which directly follows the Bank of England’s base rate. You’ll need to check the small print on your mortgage documents to understand how quickly the increase will take effect, but it’s likely that next month (September 2022) your payments are likely to go up as the base rate rises.
As an example, those with a tracker mortgage at 2.5% will see their rate go to 3%, adding £38 a month to a £150,000 repayment mortgage with 20 years left.
For the 1.1 million on an SVR, things are a bit less straightforward as they are subject to change at the lender’s discretion, but it’s likely that most people will see an increase in their monthly costs.
We spoke to a member of the team from Key Solutions Mortgages to understand their thoughts on the current market, and what they recommend to those concerned about their mortgage:
If you are concerned about rising interest rates and the impact it will have on your monthly expenditure please contact us. We can discuss your options and if you are paying the lenders Standard Variable Rate look at the best options to help you secure a new rate. If you are currently tied into a fixed rate deal we can start the remortgage process 6 months before your rate ends, so we can look to secure a new rate early.
It is important to put these interest rate rises into context. We have experienced a prolonged period of very low interest rates and so these rises are not unusual, however in conjunction with the increased cost of living they are having more of an impact for borrowers than maybe they have in the past.
Nicola Currell – Mortgage and Protection Manager
We advise you fully understand the type of mortgage you have, and contact us if you have any specific questions or queries you’d like to discuss. You can also read through our articles about Remortgaging to get an idea if this is an option worth considering.
