UK mortgage interest rate options

Once you’ve decided on whether you are going to make payments on the capital or not, you need to turn your mind to interest rate options. There are many different ways of calculating the interest due – all of which have their advantages and disadvantages, depending on your circumstances. Add to this a number of other special types of mortgages – and you have a lot to choose from. Take a look at our current mortgage rates for a list of the ‘Best Buys’ in each of the following categories.

 

 

Variable Rate Mortgages

A variable rate mortgage is one that reacts to changes in the Bank of England base rate, or some other index that is used as a benchmark. As such, the majority of all interest rates can be broadly classed as variable rate mortgages.

However, when people talk about variable rate mortgages, most are referring to products that charge a particular lender’s Standard Variable Rate (SVR) of interest. 

The SVR is the rate of interest upon which most other products on offer from a particular lender are based. More often than not, a lender’s SVR is itself linked to the Bank of England base rate, though it is usually set at a level of the base rate plus a certain number of percentage points. When the base rate changes, the lender reacts by making a corresponding increase or decrease to its own SVR, though not all lenders will alter their SVR immediately every time the base rate changes, or necessarily by exactly the same amount.

Certain mortgages will require the borrower to pay the lender’s SVR on the full balance of a mortgage from the outset. Others will revert to the SVR on completion of the introductory fixed, discounted, or other form of offer period.

 

Advantages

SVR mortgages are more widely available than any other type of rate. Borrowers looking for adverse credit, buy to let, let to buy, self-build, 100%, cashback or self certification mortgages may find that they do not meet the lending criteria that would enable them to take out some of the more competitive offers available on the market. The sheer volume of mainstream and specialist lenders offering SVR products means that they are more likely to be able to find this type of mortgage. 

SVR mortgages usually offer virtually unrestricted movement, particularly when a customer is paying the SVR having previously been on some form of introductory offer. Most customers of this type will be able to move to another mortgage product or a different lender without fear of being hit with redemption penalties. However, this is not always the case, as some products have redemption penalties that last beyond the offer period or that are payable for an extended period of time due to particularly relaxed lending criteria, cashback deals, or some other reason.

 

Disadvantages

Although this type of mortgage is the most common type of rate in this country, it is certainly not a type of product that is suitable for everyone to take out at the start of a mortgage term. Unless it is associated with a flexible mortgage, or some other form of specialist product, most borrowers will find that fixed or discounted deals usually offer far more attractive rates. Furthermore, SVR mortgages offer unpredictable levels of monthly repayments, which do not allow new homeowners to accurately budget for their repayments.

However, if you eventually want to pay your mortgage off and avoid remortgaging forever, it is inevitable that you are going to have to content yourself with paying a lender’s SVR at some point in the future. So if you are looking for a long-term deal, it is important to make sure that your lender has a good track record of offering a competitive Standard Variable Rate.

 

 

Fixed Rate Mortgages

Fixed rate mortgages guarantee a specific rate of interest for a set length of time. Most commonly, this is for between one and five years, though it can be as long as ten, fifteen or even 20 years.

As a rule, the longer the fixed period, the higher the rate of interest will be. A lender will not want to commit to lending you money at a really low interest rate for ten years, when there is a fair chance that during that period the general level of interest rates may rise above the rate at which they are lending you money. Therefore, among fixed rate deals, the lowest interest rates are usually to be found with deals that are fixed for one, two or three years. 

It is also possible to find stepped fixed rate mortgages, where the interest rate is, for example, fixed at one level for one year and then a slightly higher level for two further years.

 

Advantages

One of the best things about fixed rate mortgages is that they provide you with certainty in an uncertain world. Whatever happens to the economy and irrespective of any changes in the Bank of England base rate or the lender’s own SVR, the interest rate payable on your mortgage will stay the same during the fixed period. This makes it much easier to budget for the costs of home ownership with a fixed rate mortgage than it is with any other type of rate, as you can be sure that your repayments will stay the same for a certain period of time.

A good time to buy a fixed rate mortgage is often when the base rate is at a historically low level, or when there is a strong possibility that the Bank of England Monetary Policy Committee (MPC) will raise the level of interest rates at some point in the not too distant future. Your repayments would be protected against any increase in lending rates that followed a base rate rise – something that would not be the case had you opted for a discounted rate mortgage.

 

Disadvantages

Although fixed rate mortgages give you security that your repayments will not rise, this peace of mind usually comes at a slight cost, in that fixed rate mortgages are often offered with marginally less competitive rates that an equivalent discounted rate mortgage. 

Furthermore, you could potentially be locking your repayments at a needlessly high level were interest rates to fall during the fixed period. Take the year 2001 for example. During the course of the year, the MPC made 7 cuts to the base rate, a pattern that was mimicked by the majority of lenders with repeated cuts in their lending rates. Any mortgage customers who fixed their rate of interest at the start of 2001 will have missed out on these successive reductions and are probably still paying a rate of interest that is considerably higher than that which is available to new borrowers. 

Of course, customers that are stuck paying an uncompetitive fixed rate of interest could always switch to another product or remortgage with a different lender. But another feature of fixed rate mortgages is that they normally tie the borrower into the deal with expensive early redemption penalties that become payable should the customer wish to change mortgages within the fixed period. 

This is understandable and acceptable to most people, as long as the redemption penalties are only payable for the duration of the fixed period. However, some of the most competitive fixed rate mortgages have a redemption penalty overhang or ‘extended tie-in’. This is where the redemption penalty continues beyond the fixed rate period, effectively tying you in for a longer period. At the end of the fixed period, the rate of interest payable will revert to the lender’s Standard Variable Rate, which is usually much higher than that rate you were previously paying. 

A final point that you need to be aware of, which is a feature of all mortgage rates that come with some form of introductory offer, is the possibility of an interest rate shock at the end of the fixed rate period. This is simply where your mortgage repayments jump upwards from one month to the next due to the higher rate of interest payable on your loan after the end of the introductory period. With a fixed rate mortgage, this phenomenon can be made all the more difficult financially if the base rate and subsequently the lender’s SVR have climbed during the fixed period, making the hike in repayments all the more severe.

 

 

Discounted Rate Mortgages

With a discounted rate mortgage, the Standard Variable Rate of a lender is temporarily reduced by a set amount for a specified period, usually from one to five years. Once the discounted period is over, borrowers then revert to paying the prevailing Standard Variable Rate.

With this type of mortgage, it is the discount that is fixed and not the actual rate payable. An example is a rate that is guaranteed to have a 1.75% discount from the SVR for 3 years. If the Bank of England base rate rises or falls and the lender follows suit with their own SVR, your discounted rate will also change accordingly. 

It is quite common to find mortgages with a number of steps in the discount. You may find that you start out paying a significantly reduced rate for six months. The discount is then reduced, so your rate rises slightly. Following a second period of a lesser discount, the rate usually reverts to the SVR, but there may even be a third step in the discount before doing so. 

Advantages 
Some of the most competitive initial rates are to be found with discounted mortgages. The discounts can be quite substantial, with introductory rates as low as one or two percent far from uncommon. This can be incredibly useful if you are going to have a lot of other expenses once you have bought your house.

The initial rate is often slightly lower than with an equivalent fixed rate product, since the lender has the security of knowing they will be able to charge you more interest if the Bank of England raises interest rates. 

Finally, with a discounted rate of interest, you can benefit from a fall in the base rate – unlike a fixed rate, you will enjoy lower repayments when the lender lowers their SVR. 

Disadvantages
Unlike a fixed rate, you don’t have any control over how high your rate can go. There is nothing to say that the MPC won’t make half a dozen rate increases within a 12 month period, and if base rates start to spiral, your interest rate will be sure to follow soon after. 

The heavier the discounts, the more severe payment shocks when the discount period ends and the monthly repayments jump by a large amount to match the SVR. You must be sure that you can budget for this in your monthly expenses.

Discounted mortgages almost always have heavy redemption penalties for the duration of the discounted period. The penalties can be stepped as well as the discount, so that you get added punishment if you wish to change your mortgage during or immediately after the period of greatest discount. 

As with fixed rate mortgages, the early redemption penalty can overhang the duration of the discount period, especially with those products with extremely competitive initial discounts.

 

 

Tracker Mortgages

Tracker mortgages are increasingly common. They are usually linked to the Bank of England base rate, in that you pay a set margin above the current base rate level. Unlike many of the other types of rate, most tracker rates will not revert to a lender’s SVR at any point during the life of the loan. They will continue to track the base rate until you have either paid off your mortgage or switch provider or product.

Advantages 
There is no need to rely on your lender cutting rates in line with bank base rates, which some don’t necessarily always do immediately after an interest rate decision.

Your mortgage will never revert to the SVR, so you have some security in that you will never be paying a highly uncompetitive rate.

It is quite common to find tracker mortgages that have discounts and stepped discounts built into them, providing an added benefit. You may, for example, pay 0.75% below the Bank of England base rate for 1 year, after which time the rate is guaranteed to be not more than 1.75 % above the base rate for the remaining duration of the loan. As with other stepped products, there can be numerous steps in the discount before it settles at the final level and while pure tracker mortgages may be free of redemption penalties, those with discounts attached will almost certainly not be. 

Disadvantages
As with other variable rates, you can be in for a rough and unpredictable ride, particularly if the MPC were to make a series of rate increases. Any volatility in interest rates makes it difficult to budget for mortgage repayments, thereby making this type of rate unsuitable for some borrowers.

 

 

Capped Rate Mortgages

As with all variable mortgages, the interest rate on a capped mortgage follows the lender’s SVR up and down. The difference with this type of mortgage is that the rate is guaranteed not to go above the level at which it is ‘capped’. This cap will not last the entire life of the mortgage, but it is common to find rates that are capped for five years or more. 

Advantages 
This type of mortgage is particularly popular in times where interest rates may be likely to rise, since they offer protection against repayments going above a certain level. This makes capped rate mortgages almost as attractive as fixed rate mortgages to those borrowers who are keen to set their repayment budget for a specific period of time. 

While capped rates prevent repayments rising above a certain level, they still allow you to enjoy the benefits of any cuts that the lender makes to its SVR. A capped rate mortgage does not deny you the savings that arise from falling rates. Furthermore, it is possible to find capped rate mortgages that also come with an initial discount in addition to the cap. 

Disadvantages
Despite the availability of discounts in conjunction with a cap on the interest rate, the rate is usually higher than comparable fixed rate or pure discounted products. So although they are a safe choice of mortgage, they are a fairly conservative one, as you will never have the cheapest rate available on the market. If rates go as high as, or above the level of your cap, you would have been better with a rate fixed at a lower level. If rates drop or stay below the cap, a discounted rate will normally be better value than a capped rate.

This type of mortgage also often has redemption penalties, sometimes with an overhang beyond the capped rate period.

 

 

Cap and Collar

This is the same as a capped mortgage, but with a lower limit as well, meaning that your bets are hedged in both directions. The mortgage rate is therefore guaranteed to be within a set margin for the duration of the cap and collar period. 

Like a capped rate product, this is a safe and risk-free type of mortgage. Although the rate may be marginally cheaper than a capped rate (but still less competitive than an equivalent fixed or discounted product), you are losing some of the potential gains if interest rates drop, since the rate you pay will not go below the collar rate.

 

 

Cashback Mortgages

Cashback mortgages provide you with a single lump sum of cash either immediately on completion of the mortgage transaction or after the first monthly repayment. 

The amount of the lump sum is usually calculated as a percentage of the overall loan amount, though it can be a set figure. Some lenders offer a sliding scale of cashback, depending on how long borrowers are willing to tie themselves in to the deal. Although cashback amounts in the region of 1 to 3% are fairly common, the percentage of the loan that is given as cashback can be as high as 10%. Such seemingly great deals don’t usually come without strings attached however, usually in the form of very severe early redemption penalties that may well involve the repayment of some, all or even more than the cashback value. 

It is quite common to find mortgages that include a relatively small cashback element, possibly in the region of £200 to £300. This can be a cash sum for you to spend as you wish, though it sometimes has a specified purpose, such as covering all or part of your solicitor fees. This type of cashback deal does not usually have such severe penalties and may well not be advertised as a cashback mortgage. 

Various different types of rate can come with cashback – capped, discounted, fixed and variable, with cashback products usually available for both mortgages and remortgages. It is not common to associate cashback schemes with UK-based foreign currency mortgages, tracker mortgages or other non-standard loans. 

Advantages 
Cashback schemes can be useful for buyers who need to have funds available more or less immediately after the mortgage is completed. Although most cashback deals are open to all borrowers, one group with whom they are particular popular is first time buyers. The cashback sum is often used to buy furniture, fittings and other mod cons that they may not already have, or used to cover the cost of stamp duty, surveys, legal fees or other such incidentals.

Disadvantages
The rate of interest is likely to be higher than for non-cashback equivalents, since the lender will seek to recoup the cashback sum over the life of the loan by charging you more for the privilege of borrowing the money. By opting for a cash bonus, you will normally be giving up the option of a competitive fixed rate or a hefty initial discount.

It is often the case that the higher the cashback the less competitive the rate of interest, either during any discount period or once the mortgage reverts to the lender’s SVR. The more the lender gives you up front, the more they will need to charge you to make the money back in the long term. When you take into account the build up of interest over time that the higher rate will accrue, this form of mortgage often proves to be relatively inefficient. 

Cashback mortgages almost always carry early redemption penalties. If you try to pay off the mortgage within the penalty period, whether by selling your home or remortgaging, you may have to pay a fairly substantial sum of money back to the lender. Some lenders operate a sliding scale of penalties, which decrease each year, or in steps, while others will charge the same penalty for the entire early redemption period. 

The size of the cashback sum is often linked to the percentage of the property value that a customer is seeking to borrow. Some of the largest cashback deals are available only to those borrowers with a 75 percent deposit. Where this is the case, it can be cheaper in the long run to go for a more competitive non-cashback loan worth a larger percentage of the property value and hang on to some of the cash that was otherwise earmarked for the deposit. Where a lender operates such an incremental cashback scheme, the same reasoning applies at higher loan-to-value amounts.

 

 

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