Written by: Danny Belton - Head of Lending

When it comes to mortgages, and determining how much you’ll pay each month, interest rates have a crucial role to play. Whether you’re a first time buyer or a seasoned homeowner looking to remortgage, understanding mortgage interest rates is essential. 

Let’s demystify the wide world of interest rates and make it easier to make informed decisions next time you apply for a mortgage.

What is a mortgage interest rate?

In its simplest form, an interest rate is the percentage a lender will charge you, the borrower, in exchange for lending you the money you need. When you take out a mortgage, the interest rate represents the cost of borrowing the principal amount (the amount of money you’ve asked for) over a specified time period. 

The interest rate will be expressed as a percentage and is usually calculated based on the outstanding balance of your loan. It is important to note that interest rates will affect the overall cost of your mortgage.

How do mortgage interest rates affect what I pay?

The easiest way to explain how this works is with an example! Let’s say Keanu Reeves wants to buy a house and he finds one he likes for £300,000. Keanu will work with his mortgage adviser to find a deal that suits his needs. If the interest rate is 4.5% and the mortgage term is 25 years, we would say that Keanu would pay around £1,668 per month, for the first two years of his fixed rate deal.

Higher interest rates mean you will pay more over the life of the loan and could lead to larger monthly payments, so it’s important to ensure you’re getting a deal that suits your budget and needs.

There may be minor fluctuations and payment plans may vary from lender to lender. For example, Keanu may pay more upfront in his first month and then go onto a standard payment, or he may start off paying the same amount right off the bat. It’s also worth noting that most interest rates are calculated off a monthly basis. 

Ultimately any rates given are indicative and only your lender will be able to provide you with solid figures. Another way to calculate how much you’re likely to pay on your mortgage as a whole is to look at your annual percentage rate of charge.

hand holding up torn british bank note

Annual percentage rate of charge 

The annual percentage rate of charge is similar to an APR (annual percentage rate) but it’s the term used specifically when comparing mortgages and secured loans. When applying for a mortgage you’ll either be accepted or you won’t, unlike with credit cards and unsecured loans, where you’ll be offered a different interest rate or APR for the same deal (usually based on your credit score). 

A mortgage APRC will indicate the overall cost of borrowing across the whole term of your deal, provided the interest rate doesn’t change. That being said, more often than not the rate will change, either because you’re on a variable or tracker rate, or because you decide to remortgage. 

It’s definitely helpful to compare mortgage deals and use a mortgage broker to ensure you’re finding a deal that suits your individual needs and circumstances.

How are interest rates calculated?

Lenders will calculate interest rates using various factors, including market conditions, lender policies, and your creditworthiness. There is no specific formula, as it will vary between lenders, but the most common method is to start with the principal amount, the duration of the loan, and your risk profile. 

Lenders will typically assess your risk profile based on factors including: 

Based on your assessment, lenders will determine an interest rate that is reflective of market conditions, the cost of borrowing, and the level of risk they’re undertaking. Market conditions do play a role in how interest rates change as a whole, and this includes mortgage interest rates. Lenders will adjust their rates in response to the Bank of England’s (BoE) base rate, changes in inflation, and overall market trends.

Calculating interest rates is a complex process but at the end of the day it’s all about balancing the lender’s need to make a profit and your ability to repay the loan.

white calculator on grey background

What affects interest rates?

We have a great article that talks about why interest rates and inflation change, but the cheat sheet version is thus: 

The BoE, as the central bank of the UK, sets the base rate. This serves as a benchmark for interest rates across the country. Economic factors, including GDP growth, employment levels, and inflation rates will guide their decision making about this. The BoE meets to discuss the base rate and decides whether or not to change it every six weeks. 

Inflation ultimately plays the most significant role in shaping interest rates, as the BoE aims to maintain price stability by aiming for a specific inflation rate. The higher inflation is, the higher the base rate is likely to be.

What are the different types of interest rates?

When considering mortgage deals your adviser or lender will likely present a few different options to you, and some may suit your circumstances better than others. Within these deals will likely be different types of interest rates. In this we don’t just mean that the number itself is different (though it can be).

Each comes with their own set of advantages and disadvantages, which we’ll briefly touch on, but check out our article that talks about the different types of mortgages available.

Fixed interest rates

A fixed interest rate will do just that - remain fixed. Essentially, the interest you pay will remain the same throughout the length of your deal, usually offered as a “two-year fix” or “five-year fix.” So no matter what is happening in the market, your interest remains the same. 

Unless you remortgage, you will move onto your lender's standard variable rate (SVR), could be higher than your fixed rate.

Pros: Your monthly payments will remain the same

Cons: If interest rates fall you won’t benefit from lower repayments

SVR interest rates

With standard variable interest rates (SVR), the interest you pay each month can change at any time. An SVR is most likely to follow the BoE’s base rate movements, though there may be slight variations. 

If you’re on your mortgage lender’s SVR, you’ll stay on this rate as long as your mortgage lasts or until you opt to take out a new mortgage deal.

Pros: The freedom to change deals at any time

Cons: Your rate can change at any time throughout your loan and you are likely paying more than you need to

Tracker rates

Tracker rates are directly linked to another interest rate, typically the BoE’s base rate with an additional margin. This means that if the base rate increases or decreases, your interest rate will change by the same percentage. 

Tracker rates often have a relatively short term, usually ranging from two to five years or until you switch to another deal.

Pros: If the tracked rate changes, so will your mortgage repayments

Cons: You may have to pay an early repayment charge if you choose to switch before your deal ends

If you choose to remortgage, you may have to pay an early repayment charge to your existing lender.

Can you change your interest rate?

Yes, you can, though a change may come with early repayment charges. With fixed rate deals you can switch at two points. Either at the end of your term or during your term. Changing at the end of your fixed rate means there shouldn’t be an exit fee, though there may be other costs involved. 

Changing during your term will come with early repayment fees, though some lenders may waive this if you have six months or less remaining on your current fix. You can change as needed on a SVR to a different mortgage deal and as noted, tracker rates may lock you in for a set time. 

While there are no fixed rules as to how often you can change your mortgage deal, you will likely have to pay additional charges and fees each time, which can be hefty.

man standing at fork in the roads in a green forest

How to get a good mortgage interest rate

While you can’t change market conditions, you could get an interest rate that’s more budget friendly by ensuring a few key things: 

Looking for an expert opinion?

Understanding mortgage interest rates is key to making informed decisions about your finances and long-term homeownership goals. While an adviser will be able to provide clear details and information about your deal, it’s always helpful to have your own understanding, as it makes it easier to ask questions and gather information. 

To speak to one of our expert mortgage advisers, get in touch with us today. There’s no question too big or small and we’re on hand to help you secure a mortgage that suits your individual needs and circumstances.

Important information

Your home may be repossessed if you do not keep up repayments on your mortgage.

There may be a fee for mortgage advice. The actual amount you pay will depend on your circumstances. The fee is up to 1% but a typical fee is 0.3% of the amount borrowed.

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