Understanding Mortgage Interest Rates
Unfortunately, the British education system is lacking when it comes to explaining financial products and how interest rates work. This means most people enter a mortgage search blind, trusting the advice of financial advisers and hoping they are offered the best product.
The great news is mortgage interest rates are straightforward and, in this article, we break down what a mortgage interest rate is and how to decide which type is best for you. There are other factors you should also consider when taking a mortgage, and we will tackle those too, making mortgage interest rates easy to understand.
Let’s explore mortgage interest rates further.
What Are Mortgage Interest Rates
When you borrow money, the lender you borrow from will want to make a profit. To make this profit they apply an interest rate to the amount you borrow. You can think of an interest rate as a fee for the service of borrowing money.
Different lenders use various types of interest rates, and you may find lenders that offer 0% interest on certain finance agreements and credit cards. A 0% interest rate product will often have other ways for a company to generate profit such as late payment fees.
Mortgages are highly regulated financial products and mortgage lenders must outline interest rates and fees clearly. If you check your mortgage quote or documentation, you should find the interest rate information is displayed in plain language.
There are four types of interest rates mortgage lenders use.
The two most common interest rate types in mortgages are fixed and tracker rates. A fixed rate is a static interest rate that remains the same for the product period – which is typically 2, 3, 5 year periods.
For example, a mortgage lender may offer you a fixed interest rate of 5% over 5 years. During a 5-year fixed period, your interest rate is locked in, and the lender will not change it. After the period ends, the lender will contact you to let you know your deal is ending and you will placed on the lender’s Standard Variable Rate (see below).
Tracker rates are floating interest rates that track the Bank of England base rate. If the Bank of England increases the base rate, your mortgage lender will increase your mortgage interest rate.
Your tracker rate will not match the Bank of England base rate, instead it will be a set amount above the base rate. For example, if the Bank of England base rate is 5% your mortgage interest rate may be 5.5%.
The benefit of Tracker rate products, compared to Fixed rates, is that there are normally minimal or no early repayment charges. This means that if interest rates improve in the future within your product period, you can exit the deal and refinance to a different lender with no or minimal charges.
Like fixed rates, tracker rates also have a deal term. Once this deal term ends you will be moved to a lender’s Standard Variable Rate unless you remortgage onto a new deal.
Standard Variable Rates
Standard Variable Rates (SVR) are uncompetitive interest rates because lenders can set them at whatever rate they decide. A lender can change the SVR at any time providing they give you notice of the change.
SVRs tend to be much higher than the competitive market interest rates you find when searching for a mortgage deal. There are few rules in place for lenders in setting their SVR. However, the rate must be communicated clearly to the borrower and not be usurious.
Offset Mortgage Interest Rates
The last type of popular interest rate you may come across is an offset interest rate. Offset rates are attached to savings accounts and lenders have different ways of operating them.
For example, most lenders will not pay you interest on the savings you hold and instead reduce the interest rate you are charged on the mortgage. In rare cases, with enough in savings to offset the entire mortgage, you may find your mortgage interest rate is negligible or non-existent.
Offset mortgages allow you to offset the interest you would generate on your savings against your mortgage debt.
What is Considered a Good Mortgage Interest Rate?
A ‘good interest rate’ is subjective, but it is typically a rate that enables a borrower to comfortably afford their mortgage payments. A hefty mortgage interest rate will almost always be considered a bad mortgage interest rate.
Whether a mortgage product is considered ‘good’ or not with depend on your circumstances. For example, if you are seeking stability of payment for a couple of years, a 2-year Fixed interest rate may be most suitable. Whereas, if you are looking to move home in the next couple of years and are likely to redeem your product, a 2-year Tracker interest rate may be more suitable. An experienced whole of market mortgage broker, like Boon Brokers, will assess your circumstances and offer a suitable product recommendation.
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Other Factors to Consider Alongside Your Mortgage Interest Rate
Sometimes, borrowers get wrapped up hunting for the best headline interest rate without considering other financial penalties or considerations attached to a mortgage.
Mortgage Product Term
Lenders tend to offer the lowest fixed rate over shorter deal terms. For example, a 2-year fixed rate is typically cheaper than a 5-year fixed rate with the same lender. This is because there is less risk exposure to the lender when they offer a shorter product term. However, over the last couple of years due to economic instability in the U.K, 5-year product terms have largely been cheaper than 2-year product terms. This is because the forecast for the U.K economy is far more favourable over the next 5 years compared to the next 2 years and lenders have priced their products accordingly.
You should be aware that you run the risk of interest rates dropping considerably over a 5-year timeframe and you could find you pay a lot more than you would if you took a 2-year deal and remortgaged.
Another factor is if you want to move or sell your property. Most lenders have Early Repayment Charges to financially penalise you from exiting a mortgage deal early.
Early Repayment Charges
Early Repayment Charges (ERC) can be extremely expensive with some lenders asking for 5% of the total loan value as a penalty.
When you consider some borrowers struggle to get a 5% deposit together to get a mortgage, suffering a 5% ERC can be crippling.
How Changes in Interest Rates Can Impact Your Mortgage
When you have a fixed rate, wider changes in the economy will not impact your mortgage. Once the mortgage contract is signed, the lender must abide by the terms they offered you.
Tracker rates, SVRs and offset mortgages will change according to the economy. Tracker rates follow the Bank of England base rate directly. In the case of offset rates, changes might not be marked as banks should also be increasing the savings rates offered in line with base rate changes.
Standard Variable Rates are normally set to reflect the economy and the risk a lender has on their mortgage books. In a troubled economy where a lender has extended a lot of borrowing in the past on low interest rates, the SVR will often be much higher to try and recoup losses.
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Interest rates are straightforward to understand overall, but they can be difficult to understand in respect of your personal needs.
Boon Brokers is a Whole of Market Mortgage, Insurance and Equity Release Brokerage. Boon Brokers provides fee free mortgage advice. Book your mortgage consultation and discuss your mortgage interest rate with Boon Brokers today.