The mortgage interest rate is the price you pay for borrowing money from a mortgage lender.
It is normally shown as a percentage.
Even a small difference in the rate can affect your monthly payments. It can also change how much you repay over the life of the mortgage.
Therefore, understanding interest rates can help you compare mortgage deals.
What Is Mortgage Interest?
When you take out a mortgage, you borrow money to buy a property.
The lender charges interest on that borrowing.
For example, suppose you borrow:
£200,000
Your mortgage interest is calculated using the amount you owe and the interest rate that applies.
However, the exact calculation depends on the mortgage.
What Does the Interest Rate Mean?
Mortgage rates are normally shown as an annual percentage.
For example:
4.5%
This tells you the rate of interest charged on the mortgage.
However, it does not mean you simply pay 4.5% of the original mortgage every year.
Your mortgage balance may change over time. Also, interest is normally calculated more often than once a year.
Therefore, the actual amount of interest paid depends on the mortgage terms.
How Is Mortgage Interest Calculated?
Many lenders calculate mortgage interest daily.
The lender looks at how much you owe and applies the relevant rate.
Therefore, as the balance falls on a repayment mortgage, the amount of interest charged should also reduce.
Your mortgage documents explain how your lender calculates interest.
What Is a Repayment Mortgage?
With a repayment mortgage, your regular payments cover both:
Interest
and
Part of the amount borrowed
At the beginning, a larger share of the payment may go towards interest.
However, the balance should fall as you make payments.
As a result, more of later payments can go towards repaying the mortgage itself.
A Simple Repayment Example
Suppose you borrow:
£200,000
over:
25 years
The interest rate affects the monthly payment.
A higher rate means more interest is being charged. Therefore, the monthly payment will normally be higher.
In contrast, a lower rate will normally reduce the payment.
This is why changes in mortgage rates can make a large difference to affordability.
What Is an Interest-Only Mortgage?
An interest-only mortgage works differently.
Your regular payments normally cover the interest charged.
However, they do not normally reduce the original amount borrowed.
For example, if you borrow:
£200,000
you could still owe £200,000 when the mortgage term ends.
Therefore, you need a suitable way to repay the capital.
Why Do Mortgage Rates Change?
Mortgage rates are affected by several factors.
These include:
- Bank of England interest rates
- financial market expectations
- the cost of funding for lenders
- competition between lenders
- wider economic conditions
- the type of mortgage
Therefore, mortgage rates can change even when the Bank of England base rate has not changed.
What Is the Bank of England Base Rate?
The Bank Rate is an interest rate set by the Bank of England.
It can influence borrowing costs across the economy.
Therefore, changes in Bank Rate can affect mortgage rates.
However, the link is not always direct.
Different types of mortgage react in different ways.
Does a Base Rate Cut Mean Mortgage Rates Will Fall?
Not necessarily.
A reduction in Bank Rate can help bring some borrowing costs down.
However, lenders consider other factors when setting mortgage rates.
Markets may also expect a rate cut before it actually happens.
Therefore, some mortgage rates may move before the Bank of England makes its decision.
Likewise, mortgage rates can sometimes rise even when Bank Rate stays the same.
How Does Bank Rate Affect Tracker Mortgages?
A tracker mortgage normally follows a set rate, often Bank Rate.
For example:
Bank Rate + 0.75%
If Bank Rate is 4%, the mortgage rate would be:
4.75%
If Bank Rate falls to 3.5%, the mortgage rate could fall to:
4.25%
However, if Bank Rate rises to 4.5%, the mortgage rate could increase to:
5.25%
Therefore, tracker mortgage payments can change.
How Does Bank Rate Affect Fixed Mortgages?
Fixed mortgage rates work differently.
Once your rate is fixed, it normally stays the same for the agreed period.
Therefore, a Bank Rate change does not normally alter an existing fixed rate.
However, Bank Rate and financial market expectations can affect the new fixed-rate deals offered by lenders.
As a result, the fixed rates available to new borrowers can rise or fall.
What Are Swap Rates?
You may hear swap rates mentioned when mortgage rates change.
In simple terms, swap rates are financial market rates that can affect the cost of offering fixed-rate mortgages.
They reflect market expectations about future interest rates and other factors.
Therefore, fixed mortgage rates can move even before Bank Rate changes.
You do not need to follow swap rates to choose a mortgage. However, they help explain why fixed mortgage pricing does not always move with Bank Rate.
Why Do Different Borrowers Get Different Rates?
Not every borrower has access to the same mortgage rates.
The rate available to you can depend on factors such as:
- your deposit
- Loan-to-Value
- type of property
- type of mortgage
- length of the deal
- your circumstances
- lender rules
Therefore, an advertised mortgage rate may not be available to everyone.
How Does Your Deposit Affect the Rate?
Your deposit affects your Loan-to-Value (LTV).
For example:
Property value: £200,000
Deposit: £20,000
Mortgage: £180,000
The LTV is:
90%
However, if you provide a £50,000 deposit:
Mortgage: £150,000
The LTV becomes:
75%
Lenders often offer different deals at different LTV levels.
Therefore, a larger deposit may give you access to lower rates.
However, this is not guaranteed.
Why Does LTV Matter?
The lender is taking a financial risk when it provides a mortgage.
A lower LTV means you are borrowing a smaller share of the property’s value.
Therefore, lenders may offer better rates at lower LTV levels.
Common LTV levels can include:
95%
90%
85%
80%
75%
60%
However, the exact bands vary between lenders.
Fixed and Variable Interest Rates
Mortgage interest rates can be fixed or variable.
A fixed rate stays the same for an agreed period.
In contrast, a variable rate can change.
Therefore, fixed rates offer more certainty.
Variable rates may fall, but they can also rise.
The best choice depends on the mortgage and your circumstances.
What Is a Standard Variable Rate?
A Standard Variable Rate (SVR) is set by the lender.
Borrowers often move onto an SVR when an initial mortgage deal ends.
The lender can change this rate.
Therefore, your monthly payments can also change.
An SVR is not the same as Bank Rate.
Why Does the Mortgage Term Matter?
Your mortgage term also affects the amount you pay each month.
For example, repaying a mortgage over 30 years normally produces lower monthly payments than repaying the same amount over 20 years.
However, you will be borrowing the money for longer.
Therefore, you may pay more interest overall.
A lower monthly payment does not always mean a cheaper mortgage.
How Much Difference Can a Rate Make?
Even a small rate difference can matter on a large mortgage.
For example, compare:
Mortgage A: 4.0%
with:
Mortgage B: 4.5%
The difference is only 0.5 percentage points.
However, on a large mortgage held for several years, that difference can add up.
Therefore, interest rates are important when comparing mortgages.
But Don’t Compare Rates Alone
The mortgage with the lowest rate is not always the cheapest.
For example, a low-rate mortgage may have a large product fee.
Another mortgage may have a slightly higher rate but no fee.
Therefore, also compare:
- product fees
- monthly payments
- Early Repayment Charges
- mortgage term
- incentives
- flexibility
The total cost gives you a better comparison.
What Is APRC?
Mortgage information often includes an Annual Percentage Rate of Charge (APRC).
The APRC is designed to show the overall yearly cost of the mortgage as a percentage.
It takes account of the interest rate and certain other costs.
However, it normally assumes that you keep the mortgage under the stated terms for its full duration.
In reality, many borrowers change mortgage deals before the end of the full term.
Therefore, APRC is useful, but it should not be the only figure you consider.
What Is the Initial Rate?
The initial rate is the rate that applies during the first deal period.
For example, you may have:
4.2% fixed for five years
After five years, the initial deal ends.
You may then move onto the lender’s SVR unless you arrange another deal.
Therefore, check both the initial rate and what happens afterwards.
What Is a Follow-On Rate?
A follow-on rate is the rate that applies after your initial mortgage deal ends.
For many mortgages, this is the lender’s SVR.
It may be higher than your initial rate.
Therefore, it is useful to know when your deal ends.
This gives you time to review your options.
What Is a Mortgage Product Fee?
Some mortgages charge a fee for the deal.
For example:
Mortgage A
Rate: 4.1%
Fee: £1,499
Mortgage B
Rate: 4.3%
Fee: £0
Mortgage A has the lower rate.
However, the £1,499 fee needs to be considered.
Therefore, Mortgage A is not automatically the cheaper option.
Can You Add the Fee to Your Mortgage?
Some lenders allow product fees to be added to the mortgage balance.
This means you do not have to pay the fee upfront.
However, your mortgage balance becomes larger.
You may also pay interest on the fee.
Therefore, adding a fee to the mortgage can increase its total cost.
What Happens When Interest Rates Rise?
Higher mortgage rates can increase monthly payments.
This can affect people on variable mortgages quite quickly.
It can also affect borrowers when a fixed-rate deal ends.
For example, someone moving from a low fixed rate to a much higher new rate may see a large increase in their payment.
Therefore, it is useful to review your mortgage before a fixed deal ends.
What Happens When Interest Rates Fall?
Lower rates can reduce borrowing costs.
People on some variable or tracker mortgages may see their rates fall.
New fixed-rate deals may also become cheaper.
However, this is not guaranteed.
Also, someone already on a fixed mortgage will normally continue paying the agreed rate until the deal ends.
Should You Wait for Mortgage Rates to Fall?
It is impossible to know with certainty what mortgage rates will do next.
They can rise or fall.
Therefore, delaying a mortgage decision simply because you expect rates to fall can carry risks.
Instead, consider whether the mortgage is affordable at the rate available to you.
Also, consider your plans and how much certainty you need.
How Can You Reduce the Interest You Pay?
There are several ways you may be able to reduce mortgage interest.
For example, you could:
- borrow less
- provide a larger deposit
- choose a shorter mortgage term
- make overpayments
- review your mortgage when a deal ends
- compare the overall cost of different deals
However, check the mortgage terms before making overpayments.
Early Repayment Charges or limits may apply.
How Do Overpayments Affect Interest?
An overpayment reduces the amount you owe.
Therefore, there is less mortgage balance on which to charge future interest.
Over time, this can reduce the amount of interest you pay.
It may also help you repay the mortgage sooner.
However, the effect depends on your mortgage and how the lender handles overpayments.
Why Your Mortgage Balance Matters
Interest is linked to the amount you owe.
Therefore, a larger mortgage usually means more interest.
As your repayment mortgage balance falls, the amount of interest charged should also reduce if the rate remains the same.
This is one reason overpayments can have a long-term effect.
Comparing Mortgage Rates
When comparing mortgages, look at the whole deal.
Check:
Interest rate
Monthly payment
Product fee
Length of the initial deal
Early Repayment Charges
Follow-on rate
Mortgage term
Overpayment rules
Then consider how long you expect to keep the deal.
The Key Point
Mortgage interest is the cost of borrowing money to buy a property.
The rate you pay can have a large effect on your monthly payments and total mortgage cost.
However, the lowest interest rate is not always the cheapest mortgage.
Therefore, consider the rate, fees, term and mortgage features together.
Also, remember that mortgage rates can change over time.
Understanding how they work makes it easier to compare deals and see what you are actually paying for your mortgage.