Your Guide to Mortgage Interest Rates
Having decided on the type of mortgage you would like, it is then necessary to choose the method of calculating the interest on the mortgage.
The most common methods of calculating the interest on a mortgage are:
• Variable Rate
• Fixed Rate
• Capped Rate
• Discounted Rate
Every lender will have a standard variable rate (‘SVR’) which is based on the Bank of England’s base lending rate. The lender’s SVR is usually 2% or more above the Bank of England’s base rate. When the Bank of England increase their base rate, the lender will also increase their SVR; when the Bank of England lower their base rate, the lenders will lower their SVR. The effect of this is that the repayments on a variable rate mortgage can change from one month to another, going up when the interest rate increases and lowering when the interest rate decreases.
Under a fixed rate mortgage, the interest rate is fixed for a set period of time, the most common deals being for 2 or 5 years. During this time the interest rate charged on the mortgage will remain at the same rate, regardless of whether there is a change in the SVR or the Bank of England Base Rate. The advantage of this is that when the Bank of England Base Rate increases, the interest rate charged on the mortgage will not change. The downside is that if the Bank of England Base Rate decreases the rate of interest charged on the mortgage will not decrease. Fixed Rate mortgages provide certainty as the monthly repayment will not change throughout the fixed rate period. However, should the borrower repay the mortgage before the end of the fixed rate period they may have to pay a fairly large penalty in the form of an early repayment charge. At the end of the fixed period, the interest rate will be charged on the Variable Rate basis.
In a Capped Rate mortgage the rate of interest is limited or capped so that it cannot rise beyond a set rate regardless of any changes in the Bank of England base rate. A capped mortgage rate enables the lender to take advantage of any falls in the Bank of England base rate with lower repayments without the fear of repayments rising beyond a certain amount this being that governed by the fixed or ‘capped’ interest rate.
When the borrower takes out a capped rate mortgage, they are provided with two interest rates: The interest rate that is to be paid at the start and the maximum or ‘capped rate’ of interest beyond which the rate will not rise.
The advantage of a capped rate mortgage is the protection against the interest rate rising beyond a certain point whilst still being able to benefit from any fall in interest rates. The downside of a capped rate mortgage is that the initial or starting interest rate is usually higher than the lenders SVR or fixed rate.
A further variation of the ‘Capped Rate’ mortgage is the ‘Cap and Collar’ mortgage. This is where the lender provides the borrower with a third interest rate – a minimum rate. This means that the borrower has the initial rate which will not rise beyond the ‘capped rate’ but will also not fall below the ‘collared’ rate. With this compromise, the initial rate may be more in line with the lenders SVR than it would be on a purely capped rate mortgage.
With a tracker mortgage, the rate of interest is set to follow or ‘track’ the progress of another nominated rate. For example, a tracker interest rate can be set to always be 1% above the Bank of England Base Rate. This means that every time the Bank of England Base Rate increases or decreases, the tracker interest rate will always be 1% more. Other common rates tracked are the LIBOR rate, the dollar, or the euro.
A discounted rate mortgage is one where the initial interest rate payable in the first year or so of the term is at a lower rate than the lenders SVR. After the initial agreed period, the rate will revert to the lenders SVR.