Understanding Mortgage Interest Rates

MoneyHelper

When choosing a mortgage, don’t just look at the monthly repayments. It’s important you understand how much your interest rate payments are costing you, when they might go up and what your repayments will be after this happens.

What are the different types of mortgage interest rates?

There are two main types of mortgage interest rates:

  • Fixed rate: the interest you’re charged stays the same for a number of years, typically between two to five years.
  • Variable rate: the interest rate you pay can change.

Fixed rates

The interest rate you pay will stay the same throughout the length of the deal, no matter what happens to interest rates in the market. You’ll see them advertised as ‘two-year fix’ or ‘five-year fix’, for example, along with the interest rate charged for that period.

When this period ends, you’ll move onto a standard variable rate (SVR), unless you remortgage. The SVR is likely to be significantly higher than your fixed rate, which can lead to a big increase in your monthly repayments. 

Pros

  • Peace of mind that your monthly payments will stay the same, helping you to budget.

Cons

  • Fixed rate deals are usually slightly higher than variable rate mortgages.
  • If interest rates fall, you won’t benefit.

Watch out for

  • Charges if you want to leave the deal early – you’re usually tied in for the length of the fix.
  • The end of the fixed period – you should look for a new mortgage deal two to three months before it ends. If you don’t, you’ll be moved automatically onto your lender’s standard variable rate – which is usually higher.

Think carefully about remortgaging or locking into a new deal with large early repayment charges if you’re thinking of moving house in the foreseeable future.

Most mortgages are now ‘portable’, which means they can be moved to a new property. But, moving is still treated as a new mortgage application so you will need to meet the lender’s affordability checks and other criteria to be approved for the mortgage.

If you don’t pass the checks, then your only option might be to approach other lenders, which will result in you paying the early repayment charge of your existing lender.

‘Porting’ a mortgage can often mean only the existing balance remains on the current fixed or discount deal so you need to choose another deal for any additional borrowing for the move and this new deal is unlikely to tie in with the timescale of the existing deal.

If you know you’re likely to move house within the early repayment charge period of any new deal then you may want to consider deals with low or no early repayment charges giving you more freedom to shop around amongst lenders when the time comes to move. 

Variable rates

With variable interest rates, the rate can change at any time. Make sure you have some savings set aside so that you can afford an increase in your payments if rates do rise. Variable rates are sometimes discounted for a period at the start.

Standard variable rate (SVR)

This is the interest rate a mortgage lender applies to their standard mortgage and often roughly follows the Bank of England’s base rate movements.

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

Because a lender’s SVR often follows the Bank of England rate, your rate might rise or fall after a change in the Bank of England base rate.

Pros

  • Freedom – you can leave at any time.

Cons

  • Your rate can be changed at any time during the loan.

Discounted rates

This is a discount off the lender’s standard variable rate (SVR) and only applies for a certain length of time, typically two or three years. But it pays to shop around. SVRs differ across lenders, so don’t assume that the bigger the discount, the lower the interest rate.

Example

Two banks have discount rates:

  • Bank A has a 2% discount off a SVR of 6% (so you’ll pay 4%)
  • Bank B has a 1.5% discount off a SVR of 5% (so you’ll pay 3.5%).

Although the discount is larger for Bank A, Bank B will be the cheaper option.

Pros

  • Cost – the rate starts off cheaper, which will keep monthly repayments lower.
  • If the lender cuts its SVR, you’ll pay less each month.

Cons

  • Budgeting – the lender is free to raise its SVR at any time.
  • If Bank of England base rates rise, you’ll probably see the discount rate increase too.

Watch out for

  • Charges if you want to leave before the end of the discount period.

Tracker rates

Tracker rates move directly in line with another interest rate – normally the Bank of England’s base rate plus a few percent. So if the base rate goes up by 0.5%, your rate will go up by the same amount.

They usually have a short life, typically two to five years. Although some lenders offer trackers which last for the life of your mortgage or until you switch to another deal.

Pros

  • If the rate it is tracking falls, so will your mortgage payments.

Cons

  • If the rate it is tracking increases, so will your mortgage payments.
  • You might have to pay an early repayment charge if you want to switch before the deal ends.

Watch out for

  • The small print – check your lender can’t increase rates even when the rate your mortgage is linked to hasn’t moved. It’s rare, but it has happened in the past.

Comparing deals

When comparing these deals, don’t forget to look at the fees for taking them out, as well as the exit penalties.

Useful resources

Advice NI, in association with The Good Things Foundation, is offering digital skills...
We are the leading provider of nationally accredited Advice and Guidance, Legal Advice...
Advice NI, a registered charity founded in 1995, exists to provide leadership and...
Advice NI is the leading provider of nationally accredited Advice and Guidance, Legal...
No time for a phone call? You can now get in touch with MoneyHelper using Whatsapp. The...
It can be difficult to manage all the different bills and payments in our lives. The...
Our free Budget Planner puts you in control of your household spending and analyses your...
The Midlife MOT is a tool to help you assess your current financial situation and plan...
Are you saving for a future bill? A new TV or car? Or just to have a bit in the bank?