A beginner's guide to mortgage rates
Last updated: 03/04/2023
Understanding mortgage rates is important if you’re a first-time buyer. Over time, your interest rate can make a big difference to the total cost of your home. Let’s break down what mortgage rates mean, how they impact your monthly repayments, and the different types of mortgage rates you’ll come across.
Put simply, a mortgage is a loan. It's a sum of money you borrow from a lender to buy a home. But there are two things that make a mortgage different from other types of loans you know about:
The loan is tied to your home: A mortgage is what's called a 'secured' loan. In return for lending you a large sum of money, the lender uses the property you buy as security. If you're unable to make your regular repayments, your lender has the right to repossess your home and sell it to recover the money you borrowed from them.
The loan takes a long time to repay: Mortgages are paid back (with interest) over a long period of time - known as the 'term' of your mortgage. Mortgage terms are typically around 25 - 30 years, so even if the interest rate on your mortgage is low, you'll still pay a lot for it over time.
Remember: When you get a mortgage, you’ll need to make sure you can afford the monthly repayments. If you can’t keep up with the repayments, your home may be repossessed. That’s why getting an affordable rate is an important part of finding a mortgage that’s right for you.
The interest rate on a mortgage represents the cost of borrowing the money. When you save, your savings earn interest because the bank or building society pays you for saving with them. With mortgages, it works the other way around. You pay interest to borrow money from the lender.
If you took out a £100 loan for one year with an interest rate of 1%, you'd repay £101. (The £100 loan plus £1 in interest). If the interest rate was 5%, you'd repay £105 (The £100 loan plus £5 in interest).
That's the simple maths, but interest can add up quickly when you borrow a large amount of money over a long period of time.
If you took out a £100,000 mortgage over 20 years that had a 2% interest rate you'd end up repaying £140,000 in total. (The £100,000 loan plus £40,000 in interest). But if the mortgage had a 5% instead, you'd end up repaying £200,000 in total (The £100,000 loan plus £100,000 in interest).
How much you pay back each month on your mortgage depends on a few things:
- How much you’ve borrowed in the first place
- The rate of interest charged on your mortgage
- How long your mortgage is for
- The type of mortgage you’ve chosen: fixed or variable rate
When comparing mortgage rates, you’ll come across the term loan to value (LTV). Loan to value represents the percentage of the property value you borrow as your mortgage.
Let’s say the property you want to buy is £200,000 and you have a £20,000 deposit. The deposit you have is 10% of the property's total value. The remaining 90% (£180,000 in this example) is the amount you need to borrow as your mortgage. So your mortgage LTV would be 90%. The lower your LTV, the better chance you have of accessing mortgage deals with a more favourable interest rate.
Bear in mind, as well as the interest rate there will be other fees and charges that come with buying your first home.
With a fixed-rate mortgage, the interest rate fixed at a set amount for a set period of time; usually between 2 – 5 years. This means your monthly repayments will be fixed at a set amount during this time period – they won’t change.
Advantages of fixed-rate mortgages:
A fixed rate mortgage gives you certainty about how much you’ll pay each month. And if interest rates rise, it won’t make your mortgage payments higher, because your rate is fixed.
Disadvantages of fixed rate mortgages:
If interest rates fall, you won’t benefit from lower monthly payments, because your rate is fixed. Also, interest rates on fixed-rate mortgages can be higher than those on variable-rate mortgages – this is because you’re paying for the certainty of monthly repayments that don’t change. It’s also important to be aware that you’ll be charged a fee if you want to leave a mortgage deal before the end of the fixed period.
With variable-rate mortgages, the interest rate can change at any time; usually as a result of changes to the UK economy.
Advantages of variable-rate mortgages:
If interest rates fall, you could benefit from lower monthly repayments. And initial interest rates on variable-rate mortgages tend to be lower than those on fixed-rate mortgages.
Disadvantages of variable-rate mortgages:
If interest rates rise, your monthly repayments could increase too. And you may be charged if you want to leave your mortgage deal early.
There are different types of variable-rate mortgages, including trackers and discount mortgages. With a tracker mortgage, the rate is set at a certain percentage above the Bank of England’s base rate, so your interest rate will change automatically as the base rate changes. A discount mortgage is discounted a set amount below the lender’s standard variable rate (SVR). Bear in mind that the lender sets the SVR, and can choose when to change it. Some variable-rate mortgages have floor rates; the lowest your mortgage rate can go. This means you may not see a difference in your mortgage rate if the Bank of England base rate or the SVR drop. If you choose a variable rate mortgage, it’s important to plan ahead and budget for any potential rise in interest rates.
With most mortgage deals, your interest rate will revert to your lender's standard variable rate (SVR) after your introductory period comes to an end.
Each lender sets their own standard variable rate, and they tend to be higher than other mortgage rates.
What to think about as well as your mortgage rate
Rates are really important when choosing a mortgage, but you should also consider things like fees and early repayment charges. You should also think ahead to the other regular outgoings you’ll have as a homeowner, like utility bills and council tax. It’s important not to over-stretch yourself, and feel comfortable you’ll be able to pay your mortgage every month.