The cost of a mortgage is almost entirely defined by the interest rate, so generally the lower the rate, the cheaper your mortgage will be. However, a mortgage rate is not fixed for the entire length of the deal, so there are some things you need to watch out for.
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Mortgage rates in the UK are not only set out by the mortgage provider, but are also significantly influenced by the Bank of England, which decides the 'bank rate'. This is also known as the Bank of England base rate.
The bank rate is the rate mortgage providers are charged to lend money to customers, so when this changes, the mortgage rates change too.
In response to the COVID 19 pandemic, the Bank of England decided to cut the base rate to just 0.1% in March 2020, in an effort to boost cash flow for households and small businesses.
This historically low level is bad news for savers, but great news for borrowers as mortgages and loan rates have become cheaper.
For example, a homeowner who took out a £200,000, 5 year variable rate mortgage at 1.93 per cent in August 2018 could have been paying £841 per month, when the base rate was 0.75%.
Let’s now fast forward 2 years to August 2020, when the base rate had dropped to 0.1 per cent. That variable rate could have fallen to 1.28 per cent, reducing those monthly payments to just £779, thus saving the homeowner a healthy £62 each month.
There are different types of mortgages available too, and some will fix the rate that you find, but only for a limited time, while others will roughly follow the Bank of England base rate. In this guide we explain headline mortgage rates, what they mean, and how to know if you are really getting a cheap deal.
When comparing mortgages, the mortgage rate is what stands out. This gives you a good idea of how much the mortgage will cost you and helps you compare against other deals on the market.
However, these are often simply the 'headline' mortgage rates. Just as a newspaper headline tries to draw you in, it doesn't give you the whole picture.
Headline mortgage rates usually come in the form of fixed rates and discounts.
Fixed rate mortgages refer to, what is essentially a special introductory deal that usually lasts for two years or five years. There are some deals that are longer than five years, but these are far less common.
These two or five year deals fix the mortgage rate for that period, irrespective of what happens to the Bank of England's base rate.
Fixed rate deals can be attractive as they are often lower than other standard mortgage rates, and can help customers ease into their first few years of making monthly mortgage payments as you can be sure your payments cannot increase.
However, there are two main drawbacks to a headline fixed rate mortgage deal. Firstly, if the Bank of England's base rate lowers during your fixed rate deal, your rate stays the same, meaning you could be saving money on another deal, but are locked into this one.
Secondly, once the fixed rate is over, you will be moved over to the mortgage provider's SVR (Standard Variable Rate), which is usually much higher than the fixed rate.
Fixed rate deals work best when it looks like the base rate is about to go up, meaning you have locked in a cheaper mortgage rate.
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Like fixed rate mortgages, discount mortgages give you a cheaper rate for a limited time only.
Discount mortgage rate periods are a bit more flexible and the deals can run anywhere between 20 months to five years, whereas fixed rate deals usually only run for two years or five years.
As with the fixed rate mortgages, when discount deals expire the mortgage reverts to the provider's Standard Variable Rate, which is usually much higher.
While the two headline mortgage rates appear to be very similar, discount mortgages are on variable rates, meaning they can go up or down during the discounted period.
If the Bank of England base rate goes down during your deal, then your discount will be even better, but if it goes up, then your discount won't look as good. These deals are best if you think the interest rate is likely to go down.
Here are some quick definitions of each main type of mortgage rate:
Fixed rate mortgages:
Fixed rate mortgages give you a lower fixed rate of interest for a certain length of time, usually two years or five years. This rate does not go up or down during that time, even if the Bank of England interest rate changes.
The mortgage rate will move back to the mortgage provider's Standard Variable Rate after the fixed rate deal ends.
Variable rate mortgages:
Variable rate mortgages can fluctuate, depending on the housing market as well as the Bank of England base rate.
These deals can be initially discounted giving you a cheaper variable rate for up to five years, but this can also go up or down.
The mortgage rate will move back to the mortgage provider's Standard Variable Rate after the discounted variable rate deal ends.
Tracker mortgages are also a type of variable rate mortgage, but they are guided by the Bank of England base rate. They are charged at an amount slightly higher than the current Bank of England interest rate, but will roughly follow it when it goes up or down.
They can provide a degree of security, knowing that when the bank rate goes up, your mortgage interest rate will go up, and not because of any other factors. But variable rates generally have a larger degree of risk than a fixed rate because of their unpredictability.
A lender's standard variable rate (SVR) is what the mortgage provider charges as a standard for their mortgage interest. The standard variable rate will go up when the Bank of England interest rate rises, but it might also rise due to market pressures and the economy.
In some cases, the standard variable rate might simply go up because the bank or mortgage provider believes the Bank of England base rate will rise – even if in the end it doesn't. What’s more, if the base rate is reduced, mortgage providers can choose not to reduce their SVR, or only do so by a small amount.
Almost all headline mortgage deals will revert to the lender's standard variable rate, so it is important to compare this, and not just the initial headline rate.
Mortgages come with a plethora of costs and fees, aside from the interest rate. There will usually be an initial fee of around £1,000 to £2,000 just for 'booking' the mortgage. Some mortgage deals will waive this fee but instead offer you a higher interest rate, so do the calculations and comparisons before committing to one.
Then there are the legal and valuation fees, which can quickly add up. Stamp Duty is likely to be the most expensive lump sum payment you may have to make. These costs will come up regardless of what mortgage you choose, although some providers will offer you discounts on these fees too.
But, overall, the mortgage interest rate will be your best guide to determining which mortgage is the cheapest one for you.
The Annual Percentage Rate (APR) is the amount of interest you will be charged on your debt over the course of a year.
So, if you have a mortgage debt of £10,000, and an interest rate of 5%, you will be charged £10,500 for that year. However, the APR is 'compounded', which means that you are now charged interest on £10,500, not £10,000. You are effectively paying interest on your interest.
For example, say you have 20 years left to pay your mortgage of £150,000 at a rate of 5%. The total amount will usually have been calculated in advance, but it won't add up to £157,500, because the interest is paid over a longer period. Every time you pay down the debt you reduce the interest left to pay, but the remaining amount is also charged interest.
A simpler way of understanding this is if you have savings of £10,000 at a rate of 5%, you will receive £500 by the end of the year. Your total will be £10,500, but the following year you won't have £11,000 – you will have £11,525.
This is because you will get 5% on the original amount (£10,000), plus 5% on the interest accumulated (from the £500). The interest continues to compound the longer you continue to save, but this applies to debt too.
Never simply compare the headline rates. Mortgages are usually a 25 year commitment, sometimes even longer, so expect the interest rate to fluctuate significantly during that time.
You may think you will save money just because your mortgage comparison shows one deal is cheaper than another for the first five years, but consider what the costs will be over the entire period.
Create hypothetical situations where the interest rate rises to a 'worst case' scenario, and see how that provider's standard variable rate weighs up against the others.
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