When we borrow money as a loan from a bank, finance company, or mortgage lender, there is almost always an interest rate added on top of the amount you borrow, this is partly how lenders make money. However, the interest rate on mortgages plays an important role in the cost of buying a home for the borrower.
Interest rates can be tricky to understand, but the more informed you are about how they can impact your mortgage payments, the better equipped you will be to make an informed decision when buying your first home, your next home, or remortgaging. Keep reading to find out all you need to know.
What are Mortgage Interest Rates?
In a nutshell, mortgage interest rates are a percentage of the total money borrowed from a lender, paid in addition to your monthly repayments. The type of mortgage you opt for will determine how much interest you will pay each month and over the life of your mortgage, with a higher interest rate resulting in higher monthly repayments and a more expensive mortgage overall. Your mortgage term will consist of payments toward the initial amount borrowed, plus the interest applied by your lender, which totals the overall cost of your mortgage.
What is the Base Rate of Interest?
The Bank of England (BoE) sets a base rate of interest for lending to banks and other financial borrowing organisations, including mortgage lenders. When taking out a mortgage, your lender will borrow this money from the BoE at the current base rate, which then gets incorporated into the cost of the loan taken by the borrower. When the base rate rises, borrowing becomes more expensive and vice versa.
Other Ways Mortgage Interest Rates are Determined
Several other factors influence mortgage rates in the UK, aside from the BoE base rate, these include:
- Inflation – this directly impacts the BoE’s base rate of interest. If inflation is high, the base rate will rise to reduce the amount of borrowing within the economy.
- Credit Score – lenders will inspect the credit score and report before committing to the loan, as a way of assessing their risk. A high credit score usually qualifies for a lower interest rate, while a lower credit score may result in higher interest rates and larger deposits.
- Type of Mortgage – fixed-rate, tracker, interest-only mortgages, plus how long you take the mortgage out for, whether it’s 15 or 30 years, will determine the level of interest you pay.
- Loan Amounts and Size of Deposit – a larger deposit reduces the lender’s risk, which can lead to lower interest rates, but taking out a loan amount that exceeds conforming limits may result in much higher interest rates.
- Lender and Market Competition – market conditions, risk assessments, and business models all impact the competition between lenders. Each lender wants to be the most appealing to potential borrowers, whilst also working within the parameters of the BoE’s base rate.
Different Types of Mortgages
Repayment Mortgage
This type of mortgage allows you to repay the initial loan amount plus the interest and works by reducing the initial loan amount with each payment whilst also building your equity, which is the portion of your home that you own. The more you pay off your initial borrowed amount, the less you will pay in interest. The amount of interest you pay is calculated on your remaining house balance, so as the sum of your remaining initial borrowed amount decreases, the amount of interest to pay gradually decreases also, allowing you to pay off more of your initial home balance. Types of repayment mortgages include:
- Fixed-rate mortgages involve the interest rate remaining the same for however long you fix for, usually 2 or 5 years. When the deal ends, the interest rate changes to the lender’s standard variable rate (SVR).
- Variable mortgages have a fluctuating interest rate that runs in line with the BoE base rate and works at the lender’s discretion, meaning some months will be more expensive than others. Tracker, standard variable, and discounted variable are all forms of variable mortgages.
Interest-Only Mortgage
This type of mortgage allows you to pay off only the monthly interest, without reducing the initial amount borrowed. The full loan balance is usually repaid at the end of the mortgage term.
How is the Interest Rate Calculated?
Interest rates are usually given as an annual percentage and are calculated by dividing the annual percentage by 12 (months of the year) and applying it to the remaining balance. Below is an example:
A £100,000 mortgage with a 5% interest rate – First Monthly Payment.
(0.05 ÷ 12) x £100,000 = £416.67 (interest calculation for first month)
If you have agreed to pay £600 per month for your mortgage, that will mean that £416.67 of that monthly repayment will pay off interest, leaving £183.33 to pay off the initial amount you borrowed. Reducing your overall mortgage balance to £99,816.67.
Second Monthly Payment on £99,816.67 with a 5% interest rate.
(0.05 ÷ 12) x £99,816.67 = £415.90 (interest calculation for second month)
£415.90 goes toward paying off interest, leaving £184.10 to pay off the initial borrowed amount, making your new mortgage balance £99,632.57. Your next month’s payment will then be calculated from £99,632.67.
How to Get the Best Mortgage Rate?
Various factors contribute toward getting the best mortgage and interest rate, including the type of mortgage you choose and your circumstances.
Variable-rate mortgages typically offer the lowest interest compared to fixed-rate mortgages; due to the stability fixed-rate mortgages provide over a set period, which comes at a premium. Shorter fixed-rate mortgages tend to have lower interest rates as there is less risk posed to the lender compared to longer terms, exceeding 5 years.
Speak to a Trusted Mortgage Broker to Get the Best Mortgage Rates Today
To get the best mortgage rate, speak to an independent mortgage broker like TaylorMade. We have access to hundreds of lenders on the market with the ability to find the best one to suit your circumstances.
With interest rates continuously fluctuating, it can be difficult to know where to turn to get the best deal, but rest assured we can find it. We are a mortgage broker with extensive knowledge and experience in the mortgage market, with a team of expert mortgage brokers that offer jargon-free, helpful advice so you can understand your undertaking.
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mortgage broker based in Manchester, operating throughout the UK and we’re always on hand to help you make an informed financial decision.
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