Mortgage interest rates explained
, by Matt Stevens
Almost all loans have an interest rate, and mortgages are no exception. The interest rate of a mortgage is the percentage that’s charged on top of the amount you owe, which acts as a payment for using your chosen lender’s services.
When choosing your mortgage product and provider, it’s incredibly important that you look into all of the different interest rates available to you. This is because even the smallest difference can end up saving you thousands of pounds over the term of your loan.
To help you get the best deal, we’ve put together this guide to mortgage interest rates, which will cover:
What is the interest rate on a mortgage?
When you take out a mortgage, your lender charges interest, which is a percentage of the total amount you borrow. This interest is paid in addition to your loan repayments.
Different mortgage products come with varying interest rates, so it's important to carefully consider the rate when choosing a mortgage. The interest rate significantly affects the total cost of your property over time. Throughout the loan term, you'll repay the principal (the amount you initially borrowed) plus the interest, which determines the overall amount you’ll pay.
Why are mortgage interest rates important?
Mortgage interest rates are important because they directly affect your monthly payments and the total cost of your loan. A higher interest rate increases your monthly payments and overall financial commitment, making your mortgage more expensive in the long run. Understanding and choosing the right interest rate is essential for managing your mortgage costs effectively.
How do mortgage interest rates work?
Your mortgage interest rate is a percentage of the amount you borrow and determines how much you'll pay in interest over the life of your loan. The way you repay this interest depends on the type of mortgage you choose.
With a repayment mortgage, your monthly payments cover both the interest and the loan principal. Each payment reduces your loan balance (or principal) and builds your equity (the portion of your home that you own). As your principal decreases, the interest is calculated on the remaining balance, so the amount of interest you pay gradually decreases, while more of your payment goes toward reducing the loan balance.
In an interest-only mortgage, you pay only the interest each month, without reducing the principal. The full loan balance is repaid at the end of the mortgage term. This type of mortgage is often used for buy-to-let properties, where the goal is to manage cash flow during the loan term and repay the principal later.
How is a mortgage interest rate calculated?
Mortgage interest rates are typically expressed as an annual percentage (e.g., 5% per annum). To calculate the monthly interest, divide the annual rate by 12 and apply it to the remaining balance -
(Annual Interest Rate ÷ 12) x Remaining Balance = Monthly Interest Charge
For example:
For a £100,000 mortgage with a 5% interest rate:
In the first month: (0.05 ÷ 12) x £100,000 = £416.67 in interest.
If your monthly payment is £600, £183.33 will go towards the principal, reducing your balance to £99,816.67.
In the second month, you’ll pay interest on the new balance:
(0.05 ÷ 12) x £99,816.67 = £415.90 in interest.
£184.10 will go towards reducing the balance further.
This process repeats monthly, with more of each payment reducing the principal as the interest decreases.
What are the current interest rates for a mortgage in the UK?
According to data from Rightmove which is correct as of August 7 2024, the average interest rate on a 5 year fixed-rate mortgage is 4.69% and the average interest rate on a 2 year fixed-rate mortgage is 5.05%, with both being relative to 75% LTV.
The tables below contain data on deals for other LTV ratios while showing the week-on-week changes they've experienced.
Current average two-year fixed mortgage rates
Loan to value (LTV) | 31 July 2024 | 7 August 2024 | Weekly change |
60% LTV | 4.59% | 4.55% | -0.04% |
75% LTV | 5.08% | 5.05% | -0.03% |
85% LTV | 5.27% | 5.24% | -0.03% |
90% LTV | 5.58% | 5.59% | +0.01% |
95% LTV | 5.96% | 5.94% | -0.02% |
Current average five-year fixed mortgage rates
Loan to value (LTV) | 31 July 2024 | 7 August 2024 | Weekly change |
60% LTV | 4.19% | 4.14% | -0.05% |
75% LTV | 4.73% | 4.69% | -0.04% |
85% LTV | 4.91% | 4.88% | -0.03% |
90% LTV | 5.12% | 5.12% | -0.00% |
95% LTV | 5.48% | 5.50% | +0.02% |
Are interest rates going down?
After raising the base rate 14 consecutive times to combat inflation, the Bank of England (BoE) lowered it for the first time in over four years, bringing it to 5% in its August 2024 meeting. With inflation now near the BoE’s 2% target, being at 2.2%, a further rate reduction is anticipated by the end of the year, though this will depend on broader economic conditions.
What can I do if my mortgage interest rate goes up?
If interest rates are rising or you're struggling with recent increases, one option is to remortgage to a better fixed rate. However, be aware that this could trigger an early repayment charge, so it's important to check for any penalties before proceeding.
You’re only affected by interest rate changes if you have a variable rate mortgage, such as a tracker mortgage. The remaining term of your mortgage should also guide your decision. For instance, if you have only a few years left on your mortgage, it may be wise to lock in a fixed rate before rates rise further.
On the other hand, if you have a long term remaining, such as 20 years, it's likely that interest rates will eventually return to more favourable levels.
What is a good mortgage rate?
A good mortgage rate varies depending on the type of mortgage and individual circumstances. The lowest rate isn’t always the best choice, as other factors play a role in determining the overall value of a mortgage product. To assess whether a rate is favourable, compare it to similar mortgage products in the market.
Keep in mind that mortgage rates fluctuate with changes in the base rate and economic conditions. Your personal financial situation also impacts what constitutes a ‘good’ rate. For instance, those with strong credit ratings or the ability to make a large deposit often have access to better rates.
What is the mortgage base rate?
The base rate is the interest rate set by the Bank of England for lending to banks. When you take out a mortgage, your lender borrows money from the Bank of England at this base rate and then passes the cost onto you. Therefore, the base rate directly affects the interest rate on your mortgage.
When the base rate rises, borrowing becomes more expensive, and saving becomes more attractive. Conversely, a lower base rate makes borrowing cheaper and saving less rewarding. These changes in the base rate influence overall economic activity, as people adjust their borrowing and saving habits, which in turn affects inflation. The Bank of England regularly adjusts the base rate to manage inflation.
The current base rate is 5%, but it is reviewed and can change monthly by the Bank of England’s Monetary Policy Committee.
What are the different types of mortgage rates?
When you start your search for the right mortgage, you’ll discover that there are different types of products that have different types of interest rates. So, here, we’ll look at the options you’ll generally have so you can choose the one that’s right for your situation.
What is a fixed-rate mortgage and how do they work?
A fixed-rate mortgage locks in your interest rate for a specified period, such as two or five years. This provides stability as your payments remain constant, regardless of market fluctuations. When the fixed-rate period ends, you’ll typically move to a standard variable rate (SVR), which is often higher. It’s usually wise to remortgage before your fixed term ends to avoid higher SVR payments.
Should I fix my mortgage rate?
Fixing your mortgage rate offers predictability and protection against interest rate rises. However, if rates fall, you might end up paying more than you would with a variable rate. Fixed rates also come with a minimum term, which could be restrictive if you plan to move soon. Evaluate your financial stability and future plans to decide if fixing is the right choice for you.
Is now the right time to fix my mortgage?
With the Bank of England's base rate recently decreasing to 5% from 5.25% and predictions of further drops owing to inflation being near its target of 2% at 2.2%, many advisors recommend waiting before fixing your rate. The same also applies to first-time buyers. However, if you’re close to the end of your current deal, a fixed rate might still be beneficial. Consult with a mortgage advisor to make an informed decision based on current trends and your specific situation.
How long should I fix my mortgage for?
Fixed-rate terms typically range from two to ten years. Shorter terms usually offer lower rates, but you risk higher rates when remortgaging. Longer terms provide stability but may have higher rates. Consider your financial situation and potential changes in the housing market when choosing the term.
What happens when my fixed-rate mortgage ends?
At the end of your fixed-rate term, you’ll automatically transition to an SVR, which can be more expensive. To avoid this, plan ahead and consider remortgaging up to six months before your term ends. A mortgage broker can help you explore new deals and secure a favourable rate.
Can I get out of a fixed-rate mortgage?
Yes, but breaking a fixed-rate mortgage early usually incurs an early repayment charge, typically 1-5% of the remaining balance. Check your mortgage agreement for specific terms and fees and make sure you read our guide to mortgage fees and charges for more information.
Can I sell my house during a fixed-rate mortgage?
Yes, but selling your house may trigger an early repayment charge, as mentioned. If possible, consider waiting until your fixed-rate term ends to avoid additional costs.
What is a variable-rate mortgage and how do they work?
With a variable-rate mortgage, your interest rate and monthly payments can fluctuate. The rate may vary based on your lender’s criteria and can be influenced by the Bank of England’s base rate. If you’re on an SVR, you might be able to remortgage without penalties.
There are three main types of variable-rate mortgages: standard variable rate (SVRs), tracker rate, and discounted rate mortgages.
What is a tracker rate mortgage?
A tracker mortgage follows the Bank of England’s base rate, plus a fixed margin. For example, if the base rate is 5% and your margin is 1%, your rate would be 6%. Trackers can have introductory periods or be lifetime trackers.
What is a discounted rate mortgage?
A discounted rate mortgage offers a fixed percentage below your lender’s SVR. For instance, if the SVR is 8% and your discount is 1%, your rate would be 7%. As the SVR changes, so does your rate, but it remains at the agreed discount level.
Which mortgages come with the lowest interest rates?
Variable-rate mortgages typically offer lower interest rates compared to fixed-rate mortgages. This is because fixed-rate mortgages provide stability by locking in your rate for a set period, such as two or five years, which comes at a premium.
Longer fixed-rate terms, like those exceeding five years, usually have higher interest rates than shorter terms. This is due to the increased risk lenders take on with longer commitments, as market rates can change significantly over time. Consequently, the longer the fixed-rate term, the higher the rate, as lenders adjust to mitigate their risk.
What is APRC?
The Annual Percentage Rate of Charge (APRC) is a comprehensive measure that evaluates the complete cost of interest and fees incurred throughout the entire duration of a mortgage loan. This calculation encompasses not only any fixed interest rate periods but also factors in the lender's standard variable rate for the remaining term of the loan.
Other mortgage costs
Mortgage products may come with additional costs, including application fees or product fees. In general, these fees can be paid upfront or added to the mortgage principal. It's important to note that when fees are added to the mortgage, they can end up costing more in the long run due to accruing interest.
When evaluating different mortgage offers, it's wise to consider options both with and without these additional fees. This allows you to compare not only the APRC, but also your potential monthly repayments, enabling you to make an informed decision about the most suitable option for your financial situation.
How to get the best mortgage rate
To get the best mortgage rate and ensure your money goes as far as possible, we would always recommend improving your credit score, having a stable income, saving for a sizable deposit, and speaking to a mortgage broker who understands the market inside and out.
Mortgage brokers will also have a professional network of people who can help to provide you with the best deal and may even have access to exclusive products that are much more affordable than those you can find yourself.
Here at The Mortgage Genie, our mortgage brokers are experts in helping our clients to find the best possible mortgage deals to suit their needs. So, if you want to ensure you pay as little interest as possible over the term of your mortgage, get in touch to discuss your needs with us today.
We also have mortgage calculators that can help you to estimate how much you’ll be able to borrow to buy a property. If you’re in the early stages of your home buying journey, use our tool to set your expectations and ensure you’re looking at properties that are within your budget.
