How interest is calculated when you take a mortgage could affect your repayments now and in the future. Whether you’re hoping to buy your first home, are ready to move, or your current mortgage deal has ended, understanding your options is important.
If you’ve been paying a mortgage over the last decade, you will have benefited from mortgages having low interest rates.
Following the 2008 financial crisis, the Bank of England (BoE) cut its base interest rate to stimulate the economy, then did so again during the 2020 pandemic. Now the economy is growing and inflation is rising, the BoE has started to increase its interest rate.
As the interest rate rises it could affect the cost of borrowing, from credit cards to loans. As a mortgage is likely to be one of the largest loans you take out, the changes could have a significant effect on your expenses. So, it’s important to know how your mortgage repayments could be affected.
The Bank of England has increased its base interest rate to 1%
After months of the BoE’s interest rate being at 0.1%, it is now 1% following a series of small increases.
The BoE increases are partly linked to the rising cost of living. Higher rates of interest can be used to slow the pace of inflation by discouraging spending and borrowing. Further interest rate rises could happen in the future too.
For some mortgage holders, these rises will already have affected how much interest they pay.
The 3 different types of mortgages explained
1. Fixed-rate mortgages
If you choose a fixed-rate mortgage, the rate of interest you pay remains the same throughout the mortgage term, often two or five years.
During this period, your interest rate won’t change, even if the BoE changes its base rate. This option can provide some certainty about your repayments and overall budget.
2. Tracker-rate mortgages
With this option, your interest rate will change if the BoE changes its base rate. So, if the base rate rises, your repayments would too.
On the other hand, if the base rate falls, your outgoings will as well. The interest charged is usually the base rate plus a defined percentage, such as 2%, which will be set by your mortgage provider.
3. Variable-rate mortgages
A variable-rate mortgage is similar to a tracker-rate mortgage, but rather than following the BoE’s base rate, it will follow your provider’s standard variable rate (SVR).
This will often rise and fall in line with the BoE’s decisions. Again, this means your repayments can change during the term of the mortgage.
A small change to the interest rate could affect your outgoings
If you currently have a tracker- or variable-rate mortgage, the level of interest you pay may already have increased in the last few months. With a fixed-rate mortgage, you may find interest rates are higher when it’s time to look for a new mortgage deal.
As you may be borrowing a large amount to purchase a home, even a small change to the interest rate you pay could affect your outgoings. Over the term of a mortgage, which could be several decades, it can mean the cost of borrowing is much higher.
Which mortgage option is right for you?
If you need to take out a new mortgage, the type of mortgage and how it will affect the interest rate you pay is important. Each option has pros and cons, and which one is right for you will depend on your priorities.
A fixed-rate mortgage could make sense if you want to understand what your repayments will be every month. This can be particularly useful if you need to manage your budget carefully.
In contrast, you may be able to access an initial lower rate of interest if you opt for a tracker- or variable-rate mortgage. However, you will need to keep in mind that your interest rate could rise during the term. This can make it difficult to manage a budget in some circumstances.
As well as choosing a type of mortgage, you will need to compare different deals from lenders. This may include comparing interest rates, but there are other factors too.
You should also consider mortgage fees, overpayment options, portability, and more. Some lenders may also offer incentives, such as cashback, to encourage you to choose them.
With so many different options to choose from, it can be difficult to know which mortgage is right for you. We’re here to help. As well as helping you to understand the different options, we can offer support throughout the application process and discuss how the interest rate will affect your repayments.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.