When choosing a mortgage, don’t just look at the monthly repayments. It’s important you understand how much interest you are being charged, what happens if your interest rate changes, and what your payments are after this.
What are the different types of mortgage interest rates?
There are two main types of mortgage interest rates:
- Fixed rate: the interest you’re charged stays the same for a number of years, typically between 2 and 10 years.
- Variable rate: the interest rate you pay can change.
Fixed rates
The interest rate you pay will stay the same throughout the length of the deal, no matter what happens to interest rates in the market.
You’ll see them advertised as ‘two-year fix’ or ‘five-year fix’, for example, along with the interest rate charged for that period.
When this period ends, you’ll move onto a standard variable rate (SVR), unless you review your deal or remortgage. The SVR is likely to be significantly higher than your fixed rate, which can lead to a big increase in your monthly repayments.
Pros
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- Peace of mind that your monthly payments will stay the same, helping you to budget.
Cons
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- Fixed rate deals are usually slightly higher than variable rate mortgages.
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- If interest rates fall, you won’t benefit.
Something that could be considered as both an advantage and a disadvantage is that fixed rate mortgages usually allow you to overpay your mortgage, typically up to 10% a year without penalty. However, variable rate mortgages may allow you to overpay without any percentage limits.
Watch out for
- Charges if you want to leave the deal early – you’re usually tied in for the length of the fix.
- The end of the fixed period – you can start to review your mortgage up to six months before your current deal ends. If you don’t, you’ll be moved automatically onto your lender’s standard variable rate – which is usually higher.
Think carefully about remortgaging or locking into a new deal with large early repayment charges if you’re thinking of moving home in the foreseeable future.
Most mortgages are now ‘portable’, which means they can be moved to a new property. But, moving is still treated as a new mortgage application so you will need to meet the lender’s affordability checks and other criteria to be approved for the mortgage.
If you don’t pass the checks, your only option might be to approach other lenders, which will result in you paying the early repayment charge of your existing lender.
‘Porting’ a mortgage can often mean only the existing balance remains on the current fixed or discount deal. This means that you need to choose another deal for any additional borrowing for the move and this new deal is unlikely to tie in with the timescale of the existing deal.
If you know you’re likely to move home within the early repayment charge period of any new deal you might want to consider deals with low or no early repayment charges. This gives you more freedom to shop around amongst lenders when the time comes to move.
Variable rates
With variable interest rates, the rate can change at any time.
Make sure you have some savings set aside so that you can afford an increase in your payments if rates do rise.
Variable rates are sometimes discounted for a period at the start.
Standard variable rate
This is the interest rate a mortgage lender applies to their standard mortgage and often roughly follows the Bank of England’s base rate movements.
If you’re on your mortgage lender’s SVR, you’ll stay on this rate as long as your mortgage lasts or until you take out another mortgage deal.
Because a lender’s SVR often follows the Bank of England rate, your rate might rise or fall after a change in the Bank of England base rate.
Pros
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- Freedom – you can leave at any time.
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There’s usually no limit on how much you can overpay during this time, for example if you wanted to make a large lump sum overpayment.
Cons
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- Your rate can be changed at any time during the loan.
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Generally, the rate is higher than other types of deals.
Discounted rates
This is a discount off the lender’s SVR and only applies for a certain length of time, typically two or three years.
But it pays to shop around. SVRs differ across lenders, so don’t assume that the bigger the discount, the lower the interest rate.
Example
Two banks have discount rates:
- Bank A has a 2% discount off an SVR of 6% (so you’ll pay 4%)
- Bank B has a 1.5% discount off an SVR of 5% (so you’ll pay 3.5%).
Although the discount is larger for Bank A, Bank B will be the cheaper option.
Pros
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- Cost – the rate starts off cheaper, which will keep monthly repayments lower.
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- If the lender cuts its SVR, you’ll pay less each month.
Cons
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- Budgeting – the lender is free to raise its SVR at any time.
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- If Bank of England base rates rise, you’ll probably see the discount rate increase too.
Watch out for
- charges if you want to leave before the end of the discount period.
Tracker rates
Tracker rates move directly in line with another interest rate – normally the Bank of England’s base rate plus a few percent.
So if the base rate goes up by 0.5%, your rate will go up by the same amount.
They usually have a short life, typically two to five years. Although some lenders offer trackers that last for the life of your mortgage or until you switch to another deal.
Pros
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- If the rate it is tracking falls, so will your mortgage payments.
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You’re not usually tied in, so you can switch deal or provider before the deal ends.
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There are usually fewer or no restrictions on making overpayments with these deals.
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You can usually switch before the deal ends without having to pay an early repayment charge – but do check with your lender and documents.
Cons
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- If the rate it is tracking increases, so will your mortgage payments.
Watch out for
- the small print – check that your lender can’t increase rates even when the rate your mortgage is linked to hasn’t moved. It’s rare, but it has happened in the past.
Comparing deals
When comparing these deals, don’t forget to look at the fees for taking them out, as well as the exit penalties.