Almost all loans have an interest rate: the percentage charged on top of the amount you owe, which acts as a payment for using the lender’s service. Mortgages are no different: interest is charged as a percentage of the loan amount (known as the ‘capital’ or ‘principal’), and this is the mortgage rate.
The mortgage rate on each product is one of the most important things to consider when comparing mortgages, because even a small difference can save you thousands over the long-term. Read on to find out:
When you take out a repayment mortgage, you’ll pay back the value of your loan plus interest over the term, in the form of monthly payments. So, a portion of each monthly payment goes towards the principal, reducing your loan and building your share of equity (the portion of your home that you own), and the rest goes towards interest fees.
Mortgage interest is calculated on your remaining balance each month, which is decreasing because of your capital payments. As a result, the amount of interest you pay decreases over time, and a larger portion of your monthly payment will go towards the capital instead.
Mortgage interest rates are expressed annually (for example, 2.4% per annum), so you need to divide this by twelve to calculate the percentage applied each month.
If your monthly payments are £600, the remaining £400 will go towards your mortgage balance.
This leave you with a balance of £99,600, so you will pay (0.024 ÷ 12) x £99,600 = £199.20 in interest the second month.
The remaining £400.80 of your payment will go towards your capital, leaving you with a mortgage balance of £99,199.80 in the third month.
And so on until your balance is paid.
Our mortgage repayments calculator is the easiest way to find out the total amount of interest you will pay over the term of a loan. Simply enter the amount you are borrowing, the length of the term and the mortgage rate.
However, it’s important to remember that your interest rate will change over time, depending on the type of mortgage you take out. Therefore, comparing the total amount of interest you will pay over the term is not necessarily a good way to find the best mortgage product for you.
What makes a good mortgage rate differs by type of mortgage. The product with the lowest rate isn’t necessarily the cheapest or most suitable product for you, because there are so many other factors involved. The best way to determine whether a lender is offering a good rate is to compare it against similar products.
It’s also important to remember that mortgage rates change depending on the base rate and economic climate at the time you take out your mortgage. Your financial circumstances can also dictate what is a ‘good’ mortgage rate: for example, it’s easier to access lower rates if you have a good credit rating, or if you can afford to put down a large deposit.
When you take out a mortgage, your lender will borrow money from the Bank of England to cover the cost. The base rate is the interest charged by the Bank of England when lending money to banks, including mortgage lenders. The lenders then pass this cost onto the borrower, meaning that the base rate has a direct influence on how much interest you can expect to pay.
An increase in the base rate makes borrowing money more expensive, and saving more rewarding. So, when the base rate is high, people tend to borrow less and save more, and vice versa when it is low. Our collective spending and saving habits can lower or increase the overall inflation rate, so the Bank of England adjusts the base rate on a regular basis in order to control inflation.
The current base rate is set at 0.5% and has been the same since November 2017. However, as this figure is reviewed by the board of governors every month, it’s liable to change at short notice.
In 2017, the average interest rate on a five-year fixed-rate mortgage was 1.99%, and the average standard variable rate was 4.23%, according to figures from Statista. This means that mortgages have been at record lows for some time. But, given that mortgage rates change all the time, the current ‘best’ rate will depend on the economic climate and your financial circumstances when you shop.
Fixing your mortgage rate means ‘locking in’ a certain interest rate for a set amount of time. Many borrowers decide to fix what they perceive to be a ‘good’ rate, in order to give them some long-term security and to protect them from rate rises in the future.
However, there’s always an element of risk involved in fixing your mortgage. If you fix and rates do rise, then you could save a lot of money, but if rates remain competitive (or fall even lower) then you might actually end up paying more. You’ll also be locked in to a minimum term with a fixed rate, so this isn’t going to work for you if you have plans to sell your home anytime soon.
If you’d like to have more security over your monthly outgoings, then fixing your mortgage can help you with budgeting. You should only opt for a variable-rate mortgage if you can afford to pay more should interest rates rise, and want to be able to take advantage should they fall.
The best time to fix your mortgage is when the rates are still relatively low, but a rate rise is likely to happen soon. Historically, one base rate rise often leads to further rises in quick succession, so it’s prudent to fix as soon as the first rise happens. This way, you can secure a lower rate before any further rises are announced.
The last rate rise was in November 2017, and saw the rate rise from 0.25% to 0.5%. Given that the rate has been very low for some time now, it’s very likely that there will be further rises in the near future — you can read more about what this could mean for your mortgage in our blog post.
Generally, fixed-rate terms last for 2, 3, 5 or 10 years. As a rule of thumb, a shorter term means a lower rate, because this is less risky for the lender. However, if interest rates rise by the time you come to remortgage, you might have been better off locking in a higher rate for a longer time. It’s impossible to predict what will happen, so it’s all about balancing the potential risk and reward in line with your own financial circumstances.
One thing to bear in mind is that you’re likely to be subject to exit fees if you wish to remortgage before your term ends. So, if there’s a good chance you’re going to move home in the next ten years, it’s unwise to lock yourself into a ten-year mortgage.
Given that the base rate doubled in November 2017 and rate rises usually happen in quick succession, it’s highly likely that we’ll see further increases to mortgage rates. The Bank of England has warned that there will be at least two more rate rises before 2021 (The Times), so borrowers on variable or tracker rates are very likely to see their interest rates rise unless they decide to fix or remortgage. The Bank of England’s Term Funding Scheme — which has been providing lenders with low-cost funding — is also coming to end, which means that lenders are increasingly likely to pass on any extra cost to their customers in the form of higher rates.
When it comes to predicting future rate rises and picking the best time to fix your mortgage, it’s important to stay on top of new developments in the market. The base rate changes according to inflation, so it’s a good idea to follow the financial news to see if a rate change is likely. Upheavals in the wider economy can have an impact on the base rate, so it’s well worth keeping an eye on the news for any impending economic changes, such as Brexit. This way, you should be able to plan ahead and pick the best time to fix or remortgage, so you can avoid paying higher rates.
We hope that this guide has helped you to understand how interest rates work, and what effect they can have on the affordability of your mortgage in the long term. The Mortgage Genie can offer expert comprehensive mortgage advice, so if you need help finding the best mortgage rates, then don’t hesitate to get in touch with a team member today. You can also view the rest of our mortgage guides for more helpful advice.
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