What mortgage interest rate do you want?
Mortgage lenders make a profit from lending you money to buy a home as they charge you interest on the money that they loan. The interest rate varies from lender to lender. Also, the type of interest rate that you have on the mortgage depends on the product you select. This can be fixed, variable, capped or discounted. At present, the most popular type of mortgage taken out in the UK is a variable rate mortgage, with 64% of mortgage applicants opting for this, in comparison to 34% opting for a fixed rate mortgage.
But just what do these terms mean and how do you know which type of interest rate would be best for you? We have provided descriptions of each type of mortgage rate and guidance as to who such interest rates could be suitable for.
Variable rate mortgages
A variable rate mortgage means that the interest rate can change over time. If the Bank of England increases its base rate, this can invariably have a knock on effect in the mortgage market as lenders have to increase their interest rates to ensure their mortgages remain profitable. Mortgage companies tend to set their interest rate 1% to 2% above the base rate.
You should consider a variable rate mortgage if:
| | 1. You are comfortable taking the risk that interest rates could go up, thus increasing your monthly mortgage repayments.
2. You want to pay as little interest as possible and variable rate mortgages tend to have lower interest rates than fixed rate mortgages.
3. Your monthly budget could accommodate successive rises in interest rates
The market has shown signs of strength in recent months and the interest rate has gone down, making variable mortgage rates cheap. |
Discounted rate mortgages
Discounted rate mortgages are a type of variable rate mortgage. In this instance the lender will set their variable mortgage interest rate then offer you a discount for an initial period. For example they may offer you 5.6% discounted by 2% for the first 12 months. This means you would only be paying 3.6% interest for the first year, although this could go up if the interest rate varies.
You should consider a discounted rate mortgage if:
| | 1. You want to pay less for an initial period.
2. You have a range of other expenses to deal with in the first year. If you are a first time buyer you could have lots of furniture and household accessories to fork out for.
3. You feel comfortable with the fact that the interest rate could go up or down as with any variable mortgage, which could increase or decrease your monthly repayments.
4. You are happy to be locked into the mortgage during the period of the discount. If you do swap you may be stung be big redemption penalties. |
Capped rate mortgages
A capped rate mortgage is a variation on the theme of a variable rate mortgage. Rather than receiving a discounted rate, this time the rate is capped for an initial period. If interest rates do rise you can only ever be charged a maximum interest rate. For example if your mortgage is capped at 6% and the base rate rises to 6.5% you can only ever be charged 6%. You also benefit that if interest rates go down your mortgage rates will go down and you will pay less every month. A capped rate mortgage is considered to be the best of both worlds.
You should consider a capped rate mortgage if:
| | 1. You want to benefit from lower interest rates than a fixed mortgage.
2. A variable rate mortgage without a cap slightly worries you as it interest rates go up your monthly repayments could become unaffordable.
3. You want to know what your maximum monthly repayment could be.
4. You want to benefit if the market rates decrease and variable rates go down.
5. You feel happy that you could either swap mortgages after the capped period has ended or afford your monthly repayments if interest rates have increased. |
Fixed rate mortgages
A fixed rate mortgage is simply a mortgage that has its interest rate fixed at the outset for an initial period. Say for example a mortgage lender offered you 6.1% fixed for 2 years, this would mean that your interest rate would be fixed at this percentage for two years and then your mortgage will revert to their standard variable rate mortgage. At this time you could either stick with your current lender or remortgage to take advantage of a better rate.
You should consider a fixed rate mortgage if:
| | 1. If you can’t keep your eye on the pulse of the market and do not want to either
You are not a risk taker and don’t want to bet that interest rates will go down and you would benefit financially if you had a variable rate.
2. If interest rates have been increasing lately then it may be a wise choice to fix your interest rate to prevent it going up any further.
3. If you would feel happier knowing exactly what every monthly mortgage repayment is going to be.
4. You need to keep a strict eye on your finances and simply wouldn’t be able to afford an increase in interest rates in your first few years.
5. You are prepared to have a slightly higher interest rate just to benefit from this. |
This comprehensive look into the types of mortgage products around should give you a far clearer understanding of the basic products available. Of course there are many variations on these themes, but the underlying principles are the same. Which type of interest rate isn’t the only thing you should understand though. You also need to know about whether the interest is calculated annually or daily, whether you want an interest only or capital repayment mortgage or if a flexible mortgage is the one for you.
The rest of this dedicated mortgage section discusses these extra considerations.
