It is important to understand that the lowest interest rate does not always mean the cheapest mortgage.
Yes, we know this sounds strange, but there could be large fees associated with the lower interest rate, and as a result the overall cost of the mortgage may be more expensive. Your broker will be able to guide you to the best option for your own unique personal circumstances, after they have discussed your goals, needs and aspirations with you.
There are two main types of mortgages:
- Fixed rate – where the interest rate remains the same for a number of years, typically between two to five years.
- Variable rate – where the interest rate can go up or down.
Fixed rate mortgages
These are the rates that you will see advertised as ‘2 year fixed’ or ‘5 year fixed’. They will generally also show you the rate of interest that you will be charged.
This means that the interest rate that you are charged will remain the same throughout the term of the deal ‘period’, no matter what happens to interest rates in the rest of the market.
Advantages
- Peace of mind that your monthly payments will remain the same.
Disadvantages
- Fixed rates are generally priced a little higher than variable rate options.
- If interest rates fall, your rate will remain the same.
Considerations
- Early Redemption Charges – you are generally tied in until the end of your fixed rate, so if you wish to exit early penalties could apply.
- Fixed Rate end date – ensure that you are aware when your fixed rate ends, otherwise you could find yourself reverting to your lenders standard variable rate, which is likely to be higher. Your broker should be aware of this and will be in touch 3 – 4 months in advance.
Variable rate mortgages
As the heading indicates, these rates are variable, and so the rate can go up as well as down.
It is much more difficult to budget effectively with variable rates. They come in several different forms:
Standard variable rate (SVR)
This is your lenders standard rate, without any fixed or discount options. It’s the rate that your mortgage will revert to when your ‘special’ rate ends. It does not have an end date and will continue until you either switch it or move your mortgage to another lender.
Changes in this rate are determined by the lender themselves but would generally follow a change in the Bank of England base rate.
It’s also important to advise that the standard rate varies across all lenders.
Advantage
- Flexibility – you can overpay or close your mortgage without penalty.
Disadvantage
- The interest rate can change at any time, either up or down.
Discount rate mortgages
This is linked to your lenders standard variable rate. Your lender offers you a discount from this rate for a specified period of time, generally 2 to 5 years.
Because the standard rate varies across all lenders, do not assume that a bigger discount means a lower rate, e.g.
Two banks offer discount rates:
- Bank 1 offers a 3% discount off their SVR of 5% (so you pay 2%)
- Bank 2 offers a 2% discount off their SVR of 3.5% (so you pay 1.5%)
So, although Bank 1 offers a 3% discount, Bank 2 is cheaper.
Advantages
- Rate starts lower keeping monthly payments down.
- If the lender reduces its SVR, your payment will reduce.
Disadvantages
- As the lender can increase this rate at anytime, it makes it more difficult to budget.
- As above, if the Bank of England increases rates, you will probably see the discount rate increase too.
Considerations:
- Early Redemption Charges – like fixed rates, you may find yourself tied in.
Tracker mortgages
These types of mortgage generally have their interest rate linked to the Bank of England base rate, though it could be another rate such as LIBOR. They are generally marketed as ‘base rate plus 1%’ for example.
So, if the base rate goes up by 0.5%, your rate will also go up by 0.5%.
Like fixed rates, they generally last for a certain period of time, say 2 to 5 years. However, some products are available known as lifetime trackers, and they last for the term of your mortgage, or until you make a change.
Advantages
- If the ‘tracked’ rate falls, so will yours.
Disadvantages
- If the ‘tracked’ rate increases, so will yours.
- Early Redemption Charges could apply.
Capped rate mortgages
The interest rate on a capped mortgage generally follows your lenders SVR. The ‘cap’ however means that your rate will not go above a pre-agreed level.
Advantages
- Your rate won’t increase above a certain level, but make sure you can afford the payments at the level of the cap.
- Your rate will fall if the SVR does.
Disadvantages
- The cap can be set at quite a high level.
- The rate is generally higher than other options.
- Your lender can change the rate at any time.
Offset mortgages.
These mortgages link your current and savings accounts to your mortgage. You then only pay interest on the difference. For example, you have a mortgage of £200k, and in your current account you have £5,000. You also have a savings account with £50,000. You would therefore only pay interest on £145,000.
You still continue to make your monthly payments every month as usual, but the savings you have act as an overpayment.
The interest you save, can result in you being able to pay off your mortgage earlier than expected.
