If you’re struggling to get your head around mortgage interest rates, you’re not alone.
From LTV to SVR, there are plenty of terms to make sense of. If you’ve never bought a home before, it can feel overwhelming.
But – interest rates are easier to understand than you might think.
Here’s a handy guide to how it all works and what you need to know.
What are mortgage interest rates?
It can be tough knowing how mortgages work, particularly for first time buyers with less knowledge of the property market.
When you buy a property and take out a loan, you agree how much you’ll borrow, how long for and how much you pay each month.
Interest rates determine how much your loan repayments will be. In short, the higher they are, the more you’ll pay. While they’re not the only thing to look at when applying for a mortgage, they’re important.
Repayment vs. interest-only mortgages
There are two main types of mortgage; your monthly payments are dependent on which you choose and your individual situation.
- Repayment mortgages are the most common – you pay a set amount each month however each month the % of that payment that goes towards interest and % that goes towards capital repayment changes. You pay interest monthly but it is worked out (almost exclusively now) on a daily basis.
- Interest-only mortgages, you’ll pay interest alone but none of the capital (capital is the amount you’re borrowing)
With repayment, the interest paid gets smaller. Essentially, you decrease the amount you owe each month. Meanwhile, with interest only, you’ll pay the same amount of interest the whole time.
This can mean you pay lower monthly repayments each month. However, you’re not paying anything back against the loan initially borrowed. You need to look at the plan as a whole to decide what’s right for you.
For example, when it comes to paying off an interest only loan, this usually comes through the sale of the house. However, this can be risky if property prices drop. With the housing market treading water, it’s impossible to predict.
How are interest rates calculated?
It’s important to know that a lender’s ‘headline rates’ might be different from your ‘individual rates’. This is because headline rates usually provide a base, but your personal circumstances can alter them.
Mortgage lenders calculate rates based on a number of different factors.
Loan to value (LTV)
The loan to value ratio is the percentage of money a lender will offer for your mortgage against the overall value of your property.
For example, if the LTV ratio is 80%, this means the lender will pay 80% of the property’s value and you’ll pay the additional 20% as a deposit. The 80% mentioned here will be the loan you’re repaying each month.
Therefore, the higher a deposit you’re able to put down, the lower your mortgage repayments will be. Generally speaking, there are more attractive interest rates the lower your LTV. When saving for a house deposit, this is something to bear in mind. Particularly for those with bad credit, a large deposit can help when it comes to securing a loan rather than having a mortgage declined.
Anything lower than 80% LTV ratio is usually considered a low risk loan by lenders. However, there are other factors that play into this.
Competition on the market
The level of competition from other mortgage lenders will play a role in determining how a lender sets their interest rates. Remember, they have their own business targets to keep in mind.
Credit history is a huge factor when it comes to mortgage interest rates.
Be mindful however that lenders do not base lending decisions on your ‘credit score’. A lender will look at particular things and weight them accordingly. Therefore you may have a poor credit score but you don’t tick any of the high-risk boxes for a lender.
Lenders are looking for a low-risk loan, and they have their own assessments of this.
The Bank of England base rate has a role to play when it comes to how much interest lenders charge. However, this is often just a benchmark.
How much interest will you pay?
This depends entirely on the type of mortgage you have and your individual circumstances.
These directly track the Bank of England’s base rate to calculate the interest. These tend to stay around 0.5-2% above the base rate. They have tracked higher and sometimes have tracked below BoE base rate too.
Fixed rate mortgages
With these, you pay the same amount of interest for a set period of time, often a few years. This means you’ll know how much you’ll be paying, helping you to budget accordingly.
Therefore, if interest rates go up – you won’t pay any more. However, if they go down, you also won’t pay any less. This can mean you end up paying a little over the odds for your fixed term if you take out a mortgage at the wrong time.
Variable rate mortgages
Interest is charged at the lender’s standard variable rate (SVR) which is subject to change. This means your mortgage payments can go up or down at any time.
After your initial repayment period comes to an end, it’s likely you’ll be put on your lender’s SVR. Many choose to switch, or remortgage, before this happens.
Discount mortgage deals are charged at the lender’s SVR, minus a set percentage. For example, if the lender’s SVR was 5% and you had a 3% discount, you’d be charged 2%.
What mortgages have the highest interest rates?
Usually, fixed rate mortgages have higher interest rates. This is because you pay for the security of knowing they won’t change at any time.
Interest rates for long-term fixed-rate deals (of five years or more) also tend to have higher interest rates because the lender needs to give themselves some security should rates of the wider market increase.
Despite this, often, it can be cheaper to be on a fixed rate than an SVR. You need to look at the deal in-depth – every situation is different.
Bear in mind that your individual circumstances also play a role. This includes everything from the house you’re buying to the income you’re on. A loan with low interest rates for someone else might not be the same for you.
How to get the best interest rates
There are many ways to secure an attractive monthly repayment plan, including:
- Check your credit score – having a good history will be hugely beneficial
- Put down a big deposit
- Use a mortgage calculator. It’s always handy to know how much you’ll be paying each month, allowing you to budget accordingly. After all, there’s no point shopping for something if you haven’t got the money to spend on it!
- Compare – don’t just go with the first option you find, comparing mortgages is always advisable. Shop around until you find the best deal for you
Struggling to find a mortgage deal that suits you?
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Last Updated: April 8th, 2022