March 13, 2012

Mortgage Interest Rates Explained

Mortgage Interest RatesWhen talking about mortgage comparison the interest rate is often viewed as the most important or primary factor, but what exactly is a mortgage interest rate?

The one thing it isn’t is a standalone measurement. The term interest rate when used in reference to a mortgage can have a mixed meaning. For example a tracker mortgage may track the bank of England base rate at half a percent for two years, then revert to the banks standard variable rate and have an APR of 4%.

There are 4 different rates associated with that one product:

  • The Bank of England Base Rate;
  • The tracker rate;
  • The standard variable rate; and
  • The APR

So what is the interest rate for that mortgage and how do you compare this to a say a fixed rate deal?

Bank of England Base Rate

The Bank of England base rate is the country’s official interest rate and as the name suggests is set by the Bank of England. This is the rate at which financial institutions can borrow money from the Bank of England and so has a direct affect on lenders interest rates.

The higher this rate the higher the cost of borrowing for everyone.

Mortgage APR

APR stands for Annual Percentage Rate of Charge and is used to compare loan rates. It’s a standard way to show the costs of borrowing so that a customer may compare deals and find the best rate.

This figure is very useful for comparing mortgage interest rates as it gives a more representative comparison between various mortgage products. All mortgage lenders are required to quote an APR for each of their products although this doesn’t guarantee you will qualify for that rate. Mortgages will almost always be subject to criteria such as your loan to value, credit history and income.

Fixed rate

The fixed rate or initial rate is the rate which a mortgage will be fixed for over a period of time.

The product may begin with a rate of 3% fixed for two years then revert to a standard variable rate (explained below). This rate will normally be quoted with information on what rate the mortgage will revert to after the period and an APR to make comparing products simpler.

This is a useful metric in conjunction with APR for comparing the competitiveness of two products.

Tracker rate

A tracker mortgage tracks the Bank of England base rate. The tracker rate will normally be quoted as a standalone figure, so for example:

Tracker rate: 2.5%

Bank of England Base Rate: 2%

Amount you’ll be paying in interest: 4.5%

These rates normally track for a set period of time then revert to a standard variable rate although it is possible to get a lifetime tracker. An APR will also be quoted with these products.

Standard Variable Rate

The standard variable rate as the name suggests is a lenders standard interest rate on a mortgage product. This rate is based off of the Bank of England Base Rate plus a percentage usually ranging from 2 to 5 percent. This means the rate will change when the Bank of England Base Rate changes.

This is the rate a mortgage will usually revert to after a fixed rate or tracker deal ends.

Capped rate

A capped rate is the maximum level an interest rate can go to no matter how the lenders standard variable rate changes.

Discounted rate

A discounted rate is a discount on the mortgage lenders standard variable rate. This discount will last for a fixed period of time then the mortgage will usually revert to the lenders standard variable rate.

Comparing Rates

As explained the APR is the most useful rate to use when comparing rates over the term of the mortgage but it’s not necessarily the best metric to make a decision by, there are many other costs to consider such as:

  • Product fees;
  • Legal fees; and
  • Valuation fees

To name but a few.

An easy way to quickly compare mortgages including all the rates and fees is to deal with a mortgage broker.

A whole of market broker can quickly compare thousands of mortgage products on your behalf then produce a personalised mortgage illustration which will give you a true comparison of costs as well as other considerations related to the mortgage such as exit fees.