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What are mortgage interest rates?

Mortgage interest rates are the percentage amount of your loan that you pay back on top of the loan itself.

But mortgages themselves can be complicated – and finding the right one for you can be daunting with so many options to consider.

Here, we’ll explain in more detail what mortgage interests are and how they work – and we’ll look at the various mortgages available to you when buying a home.

Types of mortgage and how interest rates work

There are three ways you can pay back your mortgage in the UK – repayment, interest-only or combined repayment and interest-only.

1. What are repayment mortgages?

Repayment mortgages are the most common type of property loan in the UK, and are widely available and usually the most popular with buyers.

With a repayment mortgage, you make monthly payments over an agreed term and these payments cover both the loan itself and the interest.

The main benefit of having a repayment mortgage is that your overall loan amount will reduce each month and your mortgage will be repaid in full at the end of the term.

2. What is an interest-only mortgage?

With an interest-only mortgage, your monthly repayments only cover the interest amount and not the loan itself.

This means your monthly repayments will be lower than with a repayment mortgage, but at the end of your term, you’ll still owe the total loan amount.

3. How does a combined repayment and interest-only mortgage work?

Combined repayment and interest-only mortgages are less common but are available from some lenders.

With this kind of mortgage, you’ll pay down the interest and some of the loan itself during your mortgage term, with the remaining loan amount outstanding at the end of the term.

Your mortgage and interest rate options

As well as deciding how you’ll repay your mortgage, you’ll also be able to choose the type of mortgage product that works for you.

1. Fixed rate mortgages

Fixed rate mortgages mean you’ll pay a certain interest rate for a certain period of time – this means you’ll have the peace of mind that comes with knowing your monthly payments won’t change during that time.

Lenders offer fixed rate terms of between two and 10 years, although rates for these mortgages can sometimes be higher than variable rate mortgages, as you pay a little more for the added security of fixed repayments.

2. Standard Variable Rate mortgages

Each mortgage lender in the UK sets its own Standard Variable Rate (SVR). These rates can change at any time and are usually guided by the Bank of England’s base interest rate.

So, if the base rate goes up, the SVR will usually go up – meaning if your mortgage is on the SVR, your repayments will rise.

If you take out a fixed rate mortgage, you’ll move on to the SVR once your fixed rate period is up, unless you remortgage on to another fixed or variable rate product.

3. Discounted rate mortgages

If you take out a discounted rate mortgage, you’ll pay your lender’s Standard Variable Rate (SVR) with a discount.

So, if your lender’s SVR was 4.5% and your mortgage was discounted by 1%, you’d pay 3.5% interest on your loan.

If your lender’s SVR goes up, your repayments will go up, but if it falls, your repayments will decrease.

Many discounted rate mortgages come with ‘caps’, however, which puts a maximum and minimum rate in place that they can’t go above or below, so ensure you find out exactly what this means for you before you commit.

4. Tracker mortgages

Tracker mortgages are similar to discounted rate mortgages in that the rate they offer can go up or down and alter your monthly repayments in the same way.

However, tracker mortgages follow the Bank of England’s base rate, rather than your lender’s Standard Variable Rate (SVR).

That means if your tracker mortgage is +3%, you’ll pay the Bank’s base rate, plus that amount.

The base rate is currently 0.1%, so your mortgage rate would be 3.1%.

A tracker mortgage usually lasts for a set time, for instance two years, after which time you’ll move to your lender’s SVR unless you remortgage.

What is the current mortgage interest rate?

Mortgage rates in the UK are influenced by the Bank of England’s (BOE) base interest rate.

The base rate in the UK is currently at its lowest figure in history – 0.1% – after two successive cuts in the spring of 2020 due to the impact of Covid-19.

However, while lenders usually follow the base rate when setting their own Standard Variable Rates (SVR) and fixed rates, many opted against cuts due to the increased risks of lending during the pandemic.

According to Moneyfacts’s annual mortgage review for 2020, the average Standard Variable Rate (SVR) from UK lenders was 4.41% in December 2020, while the average two-year fixed mortgage rate was 2.49%.

How to calculate mortgage interest

The best way to calculate the amount of interest you’ll pay on your mortgage is to use an online calculator.

However, even the best online calculator can’t produce a truly accurate result on the amount of mortgage interest you’d pay over the term of your loan. At the start of a fixed rate mortgage agreement, however, a rough calculation can give you an idea of the monthly interest you’ll pay for your fixed rate period.

Let’s say you have a £180,000 mortgage on a 3% fixed rate for two years:

• Convert your rate into a decimal = 0.03

• Divide it by 24 months = 0.00125

• Multiply that figure by 180,000 = 225

That means you’d pay £225 per month in interest, or £5,400 over the two-year fixed rate term.

This calculation doesn’t factor in amortisation or any other fees, however, so is a very basic look at the potential interest you’d pay.

And as it’s unlikely you’ll pay the same interest rate across the whole mortgage term, calculating your total mortgage interest amount accurately is nigh on impossible.

Mortgage amortisation

Mortgage amortisation refers to the split of your monthly repayments between interest and the loan itself.

At the start of your mortgage term, a higher percentage of your monthly repayment will be interest, meaning you’ll be paying off the loan amount itself more slowly at the beginning.

However, over the term of your mortgage, that same monthly repayment will gradually cover more of the loan and less of the interest, eventually seeing you pay off both at the end of the term.

Mortgage interest relief for landlords

Landlords were previously able to deduct their mortgage interest payments from their profits to reduce their income tax bills.

However, since April 2020, mortgage interest can no longer be deducted as an expense and landlords must claim a tax credit covering 20% of their total mortgage interest.

Can you negotiate a better mortgage rate?

While you can’t negotiate a better rate with lenders, there are plenty of things you can do to help secure the most attractive rates on offer.

Sort out your credit score

Your lender will undertake a credit check as part of your mortgage application – so ensuring yours is healthy can help you get access to more attractive mortgage rates.

A low credit score will mean lenders consider you more of a risk and this, in turn, means they could charge you a higher interest rate.

• Check your credit report regularly

• Make sure you’re listed on the electoral roll

• Correct any mistakes on your credit file

• Try not to apply for lots of credit over a short period of time

• Ensure you meet all your existing repayments

Save a bigger deposit

Of course, this isn’t always possible – but the larger your deposit, the more chance you’ll have of a lower mortgage interest rate.

Often, the more attractive interest rates are reserved for buyers with at least a 20% or 25% deposit.

Shop around for the best deal

Your mortgage is one of the biggest financial commitments you’ll make, so shopping around for the best deal is key to saving you money.

Speak to a mortgage broker in the first instance, as they often have access to more mortgages and a greater number of lenders – giving you the best chance of finding a deal that works for you.

Will mortgage rates go down in 2021?

The Bank of England’s base rate of 0.1% is the lowest in history and while the Bank could opt to put interest rates in negative territory for the first time, this seems unlikely given the success of the Covid-19 vaccination programme.

If rates were to rise, however, fixed and Standard Variable Rates (SVR) from lenders could also rise with them.

The best course of action is to always seek independent financial advice when taking out a mortgage or remortgaging on to a new deal.

Further reading…

The introduction of guaranteed 95% mortgages could help open the door to homeownership for many people with small deposits – we’ve outlined everything you need to know about the scheme.

And if you are thinking of buying a property, having a mortgage agreement in principle can help put you in a strong position – take a look at our guide, which explains what an agreement in principle is and how you can get one.

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